of Law and Finance

Year IV, no. 1, 2017

The Central Bank Journal of Law and Finance is coordinated by the National Bank of Romania – Legal Department, Director Alexandru-Nicolae Păunescu, PhD Editor-in-chief: Surica Rosentuler 1. SCIENTIFIC BOARD Mugur ISĂRESCU Academician, Romanian Academy, Corresponding member of Real Academia de Ciencias Económicas y Financieras, Barcelona, Spain Moisă ALTĂR Professor, DoFIN, Academy of Economic Studies, Bucharest, Romania, Romanian-American University, Bucharest, Romania Lucian BERCEA Professor, West University of Timişoara, Romania Radu CATANĂ Professor, Babeş Bolyai University, Cluj, Romania James Ming CHEN Professor, Justin Smith Morrill Chair in Law, Michigan State University, USA Ionuţ DUMITRU Professor, DoFIN, Academy of Economic Studies, Bucharest, Romania Ovidiu FOLCUŢ Professor, Romanian-American University, Bucharest, Romania M. Peter van der HOEK Professor, Academy of Economic Studies, Bucharest, Romania, Erasmus University (EM), Rotterdam, Netherlands Iftekhar HASAN Professor, E. Gerald Corrigan Chair in International Business and Finance, Fordham University’s Schools of Business, New York, USA Dumitru MIRON Professor, Academy of Economic Studies, Bucharest, Romania Ion STANCU Professor, Academy of Economic Studies, Bucharest, Romania Brânduşa ŞTEFĂNESCU Professor Emeritus Paul WACHTEL Professor, Stern School of Business, New York University, USA

2. EDITORIAL BOARD Tudor CIUMARA PhD, Researcher, Centre of Financial and Monetary Research, Bucharest, Romania Adrian - Ionuţ PhD, Associate Professor, Academy of Economic Studies, CODIRLAŞU Bucharest, Romania Bogdan-Octavian PhD, Senior Lecturer, Academy of Economic Studies, COZMÂNCĂ Bucharest, Romania Adina CRISTE PhD, Researcher, Centre of Financial and Monetary Research, Bucharest, Romania Constantin MARIN PhD, Researcher, Centre of Financial and Monetary Research, Bucharest, Romania Beatrice POPESCU Adviser to the Deputy Governor of the National Bank of Romania Radu RIZOIU PhD, Lecturer, Faculty of Law, University of Bucharest, Romania

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Cover by Romeo Cȋrjan, PhD

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The opinions expressed in this publication are those of the authors and do not necessarily reflect the views of the National Bank of Romania, nor do they engage it in any way.

© 2017 National Bank of Romania. All rights reserved. Published by the National Bank of Romania, 25 Lipscani Street, 030031 Bucharest | www.bnro.ro

ISSN 2392 – 9723 ISSN-L 2392 – 9723

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CONTENTS

Oluwole Owoye

The Analysis of Corruption and Economic Growth in African Countries 1

Roger Gladei, Patricia Handraman

Republic of Moldova: First-Wave Reform of Security Interests Legal Framework 23

Ana-Maria Cazacu

The External Competitiveness of the Romanian Economy 49

Andreea Oprea

The Impact of MiFID II on the Liquidity of Fixed Income Instruments 79

Alexandru M. Tănase

Two Currencies - Two Destinies: The Romanian Leu - The Moldovan Leu 105

Cristina Elena Moldovan

Supervisory Colleges: Evolving Structures and Diverse Practices. Selected Issues. 135

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vi The Analysis of Corruption and Economic Growth in African Countries

Oluwole Owoye*

Abstract

This paper uses simple theoretical models to show the effects of corruption on households' demand and consumption of goods and services, production and costs of private and public firms, government-produced goods and services, financial systems, and the aggregate economy in African countries. From a straightforward application of the theories of utility maximization, production and costs, government monopoly, and economic growth, we show that corruption: (a) reduces households' demand and consumption of goods and services, (b) increases the costs of production and decreases output, (c) reduces both savings and investment and (d) magnifies the extent of capital dilution at the steady-state per capita income in African countries. Most importantly, as capital decreases due to corruption, per-capita income dissipates in the long-run. Thus this paper provides a partial explanation as to why African countries are farther away from a sustainable economic growth path despite structural reform programs recommended by several international agencies such as the World Bank and the International Monetary Fund.

Keywords: corruption, households, firms, governments, economic growth, Africa

JEL Classification: C00, O40, 043, O55

* Professor of Economics, Department of Social Sciences/Economics, Western Connecticut State University, Danbury, CT 06810 USA. Email: [email protected], tel: 203-837-8456, fax: 203-837-3960

Central Bank Journal of Law and Finance, No. 1/2017 1 The Analysis of Corruption and Economic Growth in African Countries

1. INTRODUCTION

This paper addresses a fundamental social problem of immense proportion and with serious economic growth implications for African countries. In these countries, the increasing rate of corruption is one of the most perplexing economic and social problems they have faced since their national independence. In many African countries, corruption in the public sector has left the treasury virtually empty whenever there has been a change of government, either from a military dictatorship to an elected democratic government or vice versa. The looting of the national treasury is easy because it is very difficult to distinguish between the treasury and the personal bank accounts of top level government officials. Some economists have argued that the revenues from corruption are likely to be invested in productive activities with forward and backward linkages which will enhance economic growth. On theoretical grounds, this maybe a valid argument if corruption revenues are ploughed into the economy because macroeconomic theory suggests that leakages from the income streams are injected into the economy. Unfortunately for African countries, the revenues from corruption are stashed away in foreign bank accounts or invested in the Stock Exchange of foreign countries where confiscation would be difficult. The international community is well aware of the fact that many African leaders, as well as leaders from other developing countries, are worth millions of dollars in foreign bank accounts which cannot be justified by their total annual income even if it were invested at the highest rates of return. In this paper, we define corruption in a broad sense to include bribery, embezzlement, abuse of office, and other forms of illegal activities that cause misallocation of society's scarce resources. The abuse of office is defined as a form of government (corporate) corruption which includes the sale of government (corporate) properties for personal gain. In African countries, corrupt behaviour can manifest itself in different forms such as the unlawful transfer or exchange of money, shredding of vital documents, padding private and government payrolls with “ghost” or “graveyard” workers, and vote or election rigging. In these countries, the destruction of government buildings by arson is a common practice whenever there are inquiries that might uncover illegal and corrupt activities. For example, there are several newspapers and television reports of fires in ministries and government- owned companies that have been blamed on corrupt officials trying to hide crimes.1 More importantly, corruption compromises the health and national security of African countries. For example, some of these countries are potential dumping grounds for batches of contaminated foods, hazardous nuclear wastes, and other harmful substances in exchange for paltry foreign exchange earnings. During the 1980s, top government officials of Sierra Leone and a group of Nigerians accepted bribes from foreign companies to dump nuclear waste in these countries. This is possible because safety standards are rarely enforced; and even when enforced, standards are easily compromised because bribes are offered. A very good example in the African context is the enforcement of the emission standard. In these

2 Central Bank Journal of Law and Finance, No. 1/2017 Oluwole Owoye countries, local, and interstate highways are filled with unroadworthy vehicles that emit dangerous pollutants because the vehicle inspection officers accept bribes in order to issue vehicle permits. The main purpose of this paper is to show that corruption affects all sectors of the economy, thus it has negative effects on economic growth in African countries. With respect to the literature on corruption, the present paper innovates in several different ways. First, this study attempts to show that corruption affects the level of households' consumption using the simple utility maximization model. Second, we also show that corruption affects the production and costs of private firms and public enterprises using a modified Cobb- Douglas production function. Third, we argue that the autocratically democratic structure of governance in African countries allows governments to act as monopolies in the allocation of public goods and services thus perpetrating organized and fragmented corruption. Fourth, we use the loanable funds markets to show that corruption reduces both aggregate savings and gross private domestic investment. Finally and most significantly, we employ the conventional neoclassical growth model to show the effects of corruption on economic growth and development. In the context of the neoclassical growth model, we show that per-capita income, investment per worker, and capital-labour ratio decline because corruption distorts savings and investment equality, thus per-capita income dissipates in the long-run. In other words, we utilize the neoclassical growth model to show that corruption is one of the major reasons why African countries are farther away from a balanced growth path despite the fact that many of these countries have embarked on structural reform programs. The plan of this paper is as follows. Section 2 provides a brief literature review of studies of corruption. Section 3 presents the theoretical model to show the adverse effects of corruption on households' demand and consumption of goods and services, production and costs, and on the aggregate economy. Section 4 is devoted to concluding remarks.

2. LITERATURE REVIEW

The literature is replete with different models (agency, resource allocation, and internal markets) put forward to explain corruption and its prevalence over time. For example, the agency model assumes that legislators are motivated by self-interest and they extort payments from elite-interest groups who wish to influence legislative policies. These models explain the behaviours of autocratic dictators as predatory agents that ignore the welfare of their voting public – the principal-agent model of corruption [Rose-Ackerman (1975, 1978), Beenstock (1979)]. Basically, the principal-agent model examines the relationship between the top ranking government officials (the principals) and the lower level officials (the agents) who take bribes from private citizens that are interested in government contracts or publicly produced goods and services. For example, Rose-Ackerman’s (1978)

Central Bank Journal of Law and Finance, No. 1/2017 3 The Analysis of Corruption and Economic Growth in African Countries agency model assumes that voters are misinformed, which allows corrupt legislators to purchase their votes. In this set-up, the objective of legislators is to get re-elected and gain private income. Their ability to control grand corruption is dependent upon the strength of the existing political parties, institutions, and their methods of campaign financing. Corruption thrives on narrowly focused favours available for distribution, the ability of the wealthy elites to obtain funds legally, and the temporal stability of political alliances (Jain, 2001). Bardhan’s (1997) frequency-dependent framework of corruption considers two causes; the first being deeply rooted in Andvig’s (1991) proposition that “the regulatory state with its elaborate system of permits and licenses spawn corruption (pp. 1990)” while the second argues that social norms in business transactions affect corruption. Assuming both, Bardhan uses Schelling’s binary choice model to explain the variation of corruption across societies where the expected profitability (marginal benefits) of engaging in corruption depends on its prevalence. Bardham uses Schelling’s binary diagram to show that all the officials could be honest or corrupt and that the tipping point or threshold is reached when the proportion of corrupt officials rises as the marginal benefits of corrupt officials become much higher than those of honest officials. Interpretively, if a nation has more honest officials, it may be able to control its level of corruption because it is less profitable to be corrupt, however, once it passes the threshold where there are more corrupt officials than the honest ones, it will move to the higher level of corruption. Simply put, corrupt will persist in any country if a large proportion of the population is corrupt and the marginal benefits of few honest ones are negative. Intuitively, if one follows Bardhan’s (1997) use of Schelling’s binary diagram, one can easily conclude that Africa reached the tipping point and corruption became endemic and persistent during the era of coups d’état . Other studies by Krueger (1974), Johnson (1975), Banfield (1975), Ekpo and Aigobenebo (1985) and Lui (1985, 1986) have provided detailed microeconomic foundation of corruption. The basic conclusion from these studies is that corruption causes economic inefficiency. In one of the few country-specific studies on corruption, Ekpo and Aigobenebo (1985) used the simple supply and demand analysis to show how corruption affects prices in Nigeria. They concluded that bribery and corruption exert upward pressure on prices, presuming that corruption decreases the aggregate demand and gross national product. In a related study, Shleifer and Vishny (1993) pointed out that corruption is both pervasive and significant around the world. They indicated that, in some developing countries, such as Kenya and Zaire, corruption probably amounts to a large fraction of the gross national product. Basically, Shleifer and Vishny (1993) presented two propositions about corruption which supported the previous studies by Rose-Ackerman and others. They argued that the structure of the government institutions and of the political process is an important determinant of the level of corruption. In addition, they indicated that weak governments, such as those in African countries, which cannot control their agencies, will experience very high corruption levels. Furthermore, they

4 Central Bank Journal of Law and Finance, No. 1/2017 Oluwole Owoye argued that the illegality of corruption and the need for secrecy make it much more distortionary and costly than taxation. In contrast, Lui (1985) examined the behaviour of corrupt government officials faced with queues of bribe offers. He argued that it is possible for corruption to improve social welfare if the quest for more bribes by government officials expedites the bureaucratic process. In a subsequent study, Lui (1986) developed an overlapping generation model of corruption with multiple equilibria to explain the effects of harsh government policies on corruption. Overall, research scholars and policy experts agree that corruption is pervasive in African countries. For example, Ayittey (2002, 2011, 2012) and Lawal (2007) agree that corruption sums to more than half of Africa’s foreign debt which exceeds its foreign aid. In a study of 27 Sub-Saharan countries, Bissessar (2009) found that the percentage of African countries in the most corrupt category rose sharply between 1984 and 2006 and that a significant percentage of middle corrupt countries transitioned to highly corrupt countries over the period. Owoye and Bendardaf (1996) argued that corruption has an adverse effect on the levels of production, consumption, gross private domestic investment, government spending, net exports, employment, and money markets in developing regions such as Africa. Policy experts and international agencies, such as the World Bank and the International Monetary Fund rank public sector corruption – the use of public office for personal gains – as the major constraint hindering Africa’s economic and socio-political development [see Klitgaard (1998), Gray and Kaufmann (1998), Mauro (1998, 1995), and Vogl (1998, 2004)].2 The problem in getting a handle of the issue of corruption in African countries is that data analysis provides no useful insight in answering some pertinent research questions: Why is Africa the only major region of the world that went economically backwards during the 1980s and 1990s, with per-capita income declining yearly? Why are African people worse off today than they were 40 or 50 years ago? Why is the average African four or five times worse off than the average Southeast Asian, even though the economies of these two regions stood virtually at par some years ago?

3. THE BASIC MODEL

The above questions are difficult to answer econometrically by way of multiple regression analysis based on the corruption perception index, which critics consider to be severely subjective. Obviously, corruption is a cancerous cankerworm that has eaten deep into the socio-economic and political fabric of the African society. Worst of all, it is rapidly spreading from one generation to the next. The widespread corruption has serious economic, political, and social consequences. With respect to economic growth, corruption inhibits capital formation which growth economists agree is one of the necessary conduits for economic development. In addition, corruption not only exacerbates the problem

Central Bank Journal of Law and Finance, No. 1/2017 5 The Analysis of Corruption and Economic Growth in African Countries usually identified with all developing countries – the lack of production capacity – but the weaknesses in the industrial base and the lack of technological know-how are such that African countries cannot afford the misuse of their scarce economic resources. They do not have the capacity to absorb the resource misallocations associated with corruption. Most importantly, corruption leads to the choice of inferior goods. With respect to social and political development, corruption contributes to the social and political instability that characterise many African countries. From a social point of view, corruption breeds social anarchy thus compromising the rule of law and putting the legal system in disarray. Generally, it is well known that court judges and law enforcement agents accept bribes from defendants and complainants. In effect, the system of justice in African countries is open to the highest bribers. In terms of social amenities, the supply of water, electricity, telephone, and other essential services are hoarded until more bribes are paid by the consumers. On the political front, democracy has not flourished as anticipated because of widespread corruption. When democratic elections are held, such exercise in political reforms is marred by widespread election fraud and vote rigging. This explains the existence of authoritarian leaders and why these leaders hold-on to power no matter the social and economic costs. To solidify their strong hold to power, these corrupt leaders institute extremely harsh, but ineffective policies to deter corruption. In some cases, they initiate false democratic reforms to prolong their stay-in power. The longer they remain in power, the more they are able to siphon the nation's treasury into overseas accounts until the nation is almost bankrupt. The propensity for corruption explains why the political environment in African countries was highly unstable and coups d'état became the method to change the government from one group of corrupt military officers or politicians to the next. To fully encapsulate corruption in the African context, we need to examine its effect on households’ demand and consumption of goods and services, production and costs of manufacturing firms, and the aggregate economy. To accomplish this objective, this paper uses simple conceptual models, which are deeply rooted in microeconomic theory, to analyse corruption in African countries because we believe it is appropriate to employ the theories of consumer demand, production and costs, monopoly structure in governance, financial systems, and the neoclassical growth to explain the problem of corruption in various sectors of the economy.

3.1. Corruption and Utility Maximization by Households in African Countries The analysis of the problems of corruption begins with the households which are the main consumers of private and government-produced goods and services. The assumption is that households in African countries, just as those in developed and other less developed

6 Central Bank Journal of Law and Finance, No. 1/2017 Oluwole Owoye economies, act to maximize utility by consuming goods and services. In other words, the objective functions of households in African countries can be expressed algebraically as: Maximize U(G, S) subject to a budget constraint (Pg + θ)G + (Ps + φ)S = M (1)

where G and Pg represent different goods (normal and/or luxury) and their prices; S and Ps represent various services and their prices; and M is the money income from work. Furthermore, the representative households are assumed to be bribe payers (but may also receive bribes if they are members of the same household of highly placed government officials), and that θ and φ are the bribe prices that households pay to obtain these goods and services in any given period. We set up the Lagrangian (Լ) of equation (1) as:

Լ = U(G, S) + λ(M - PgG - θG - PsS - φS) (2), where λ is the Lagrange multiplier. Setting the first partials of the above to zero, we have:

Լ G = UG – λPg – λθ = 0 (3),

Լ S = US – λPs – λφ = 0 (4),

Լ λ = M – PgG – θG – PsS – φS = 0 (5).

The simultaneous solutions to equations (3) and (4) are straightforward and can be expressed as:

G = G (Pg, Ps, θ, φ, M) (6),

S = S (Pg, Ps, θ, φ, M) (7),

λ = λ (Pg, Ps, θ, φ, M) (8). Equations (6) and (7) show that the quantities of G and S in African countries depend on the market prices, money income, and the bribes (θ and φ) paid by households. The effects of θ and φ on the choice of G and S are illustrated graphically in Figure 1. In the absence of bribes or corruption in the 1950s and 1960s, households maximize their utility by consuming G* and S* at point A with money income (M) and given the regular prices as Pg and Ps. With endemic corruption since the 1970s, the choice of goods and services is now at point B where G** and S** are now the combination given the money income M, but with prices Pg + θ for G and Ps + φ for S. Basically, corruption has a negative effect on African households’ utility maximization because it decreases the level of consumption of goods and services. Furthermore, Figure 1 shows that bribe payments reduce the purchasing power of households in African countries thus putting them on a lower utility level. Since this analysis shows a similarity with per-unit tax on goods and services commonly analyzed under consumer preference theory, it is therefore very easy for skeptics to dismiss the importance of Figure 1 as a valid schematic framework to explain the effects of corruption on African

Central Bank Journal of Law and Finance, No. 1/2017 7 The Analysis of Corruption and Economic Growth in African Countries households’ utility maximization since the 1970s. We hasten to point out that many African households do not pay taxes and do not know the significance of the corruption perception index, which economists use to analyze the effects of corruption in their countries, but they do know the uncountable extra payments (θ + φ) made to maintain their demand and consumption of certain goods and services. Based on African households’ limited income, it is not very difficult to understand that the bribes (θ + φ) paid to consume G and S are more distortionary than either the lump-sum and/or per-unit taxation. In addition, anyone who is familiar with the tax system in African countries knows that the ill-structured system, in which tax evasion is unabated, poses a major problem in terms of the ability to generate adequate revenue.

Figure 1: Households’ Choice of Goods and Services

3.2. Corruption and the Choice/Use of Inputs by Private Firms and Public Enterprises in African Countries Here, it is also assumed that private firms and public enterprises in African countries produce goods and services3 according to the Cobb-Douglas production function. This can be expressed as:

α β Qt = K L , α + β = 1 subject to the costs constraint: TC = waLa + wgLg + (r + γ) K (9),

8 Central Bank Journal of Law and Finance, No. 1/2017 Oluwole Owoye

where Qt is the target total output over a planned time period t, K and L represent the quantities of capital and labour (which can be divided into La representing the quantity of actual labour used in the production process and Lg as the quantity of “ghost/graveyard” workers), TC is the total costs of production over a planned period, wa is the market wage rate for actual workers, wg is the hidden wage paid to “ghost/graveyard” workers which may be higher than or less than wa, r is the market rental rate or price of capital, and γ is the bribe paid for capital acquisition. Setting up the Lagrangian for equation (9) and setting the first partial derivatives equal to zero as in equations (3) and (4) in the case of the households, the simultaneous solutions are similar to those of equations (6)-(8).4

In the absence of corruption (that is, Lg = 0 thus wg = 0, and γ = 0) and if we assume the production costs remain constant over the specific planning period, the optimal choice of capital (K*) and labour (L* = La) is at point C in Figure 2 where these firms adjust their input mix until the technologically determined marginal rate of technical substitution (MRTS) equals the market price ratio (w/r) for the inputs. With bribes paid to acquire capital input and the addition of “ghost/graveyard” workers to payrolls by private and public managers, and if these firms’ production budget remains unchanged over the planned period, the level of output decreases to Q2. Producing Q2 requires input mix at point D shown in Figure 2.

Figure 2: Choice of Inputs by Private Firms and Public Enterprises

Central Bank Journal of Law and Finance, No. 1/2017 9 The Analysis of Corruption and Economic Growth in African Countries

It should be noted that even though point D is technically efficient in terms of input mix since it is the point of tangency of the isoquant and isocost line, but it is economically inefficient because output Q2 is lower than the targeted output Q1. In order to maintain output at its target level over the planned period, managers can choose the inefficient input mix at point E or point F which would require higher costs of production. This misallocation or misuse of scarce resources is one of the reasons for the unexplained shortages of output and/or why firms operate significantly below capacity in many African countries. Firms’ choice of input mix at point D or point E or point F due to corruption is analogous to the theory of second-best.

3.3. Organized-Fragmented Corruption and African Governments as Monopolies To simplify the analysis of corruption in the government sector, it is important to point out that governments in African countries have monopoly power in the provision of certain government-produced goods and services: water supply, electricity, licenses, permits, passports, and visas. It is important to point out that the governments in these countries have the discretion to restrict the production and distribution of these goods and services; thus, this provides many government officials along with their family members with the opportunity to collect bribes from prospective contractors and buyers. In addition, a common policy in many African countries is price control for the purpose of curbing inflationary pressures.

For simplicity in exposition, it is logical to assume that the control price (PC) is equal to the marginal cost (MC) of government-produced goods and services. In other words, PC = MC; and in essence, each government behaves as a self-regulated monopoly through its price control policy. Based on this assumption, the quantity of goods and services supplied by the government is sold at marginal cost. As shown in Figure 3, OQC is the quantity of government-produced goods and services available for sale at the controlled price (PC) when there is no corruption.

With corruption, quantities OQC can be sold in different ways. First, OQH is sold at the controlled price (PC) to government licensed contractors; and these licensed contractors know the required bribe (ξ) that they must pay for OQH, thus area J is the corruption revenue to the government. For the agencies or licensed contractors to sell government- produced goods and services, one can assume that they know what each buyer is willing to pay and are thus ready to charge in accordance with the buyers’ willingness thereby earning area I as their own profit. In other words, these sellers engage in price discrimination by charging prices that are greater than PC + ξ; therefore, the trapezoid shaded area I + J is the total revenue from fragmented corruption. Second, quantity OQH is sold directly to the public at the controlled price PC and it is assumed that the public is aware of the fixed amount of bribe (ξ) that must be paid in order to purchase these goods and services. This

10 Central Bank Journal of Law and Finance, No. 1/2017 Oluwole Owoye is true with respect to the extra payments that must accompany the application fees for passports, visas, permits, and licenses. Furthermore, we assume that the remaining quantities (QHQC) are sold to government officials and their family members at the controlled price PC. This is a form of corruption-induced price discrimination, which is not based on separating the markets according to different incomes and demand elasticities, but to special preferences. In essence, the shaded triangular area K is the corruption revenue to family members who acquire QHQC at the controlled price PC, not because they need these goods and services, but because they are willing to sell them to their friends and neighbours at various prices less than P + ξ. These friends and neighbours may consider this a special favour thus perpetrating corruption-induced influences. This analysis suggests that corruption network in African countries is both organized and fragmented.

Figure 3: The Allocation of Public Goods and Services

3.4. Corruption in the Financial Systems Economists agree that an efficient financial system through its financial intermediation function is central to a sustainable economic growth and development in any economy. A financial system consists of many markets through which funds flow from lenders to borrowers and these interactions determine the market interest rate and the quantity of loanable funds exchanged. In African countries, corruption has compromised the efficiency

Central Bank Journal of Law and Finance, No. 1/2017 11 The Analysis of Corruption and Economic Growth in African Countries with which their financial systems operate; and to highlight the impact of corruption on the financial systems in these countries, we examine the dynamics of the loanable funds markets.

The demand for loanable funds is determined by the willingness of firms to borrow money to engage in different investment projects such as building new plants or factories, engaging in research and development of new products or processes. There are many factors that influence firms’ investment decision, including the consideration of the expected return on an investment in comparison to the interest rate that firms must pay to borrow the necessary funds and the overall economic conditions. Algebraically, we can express the investment demand function as:

I = f (r, EFP, CIT, RE, CDB, B) (10) where I is the gross private domestic investment, r is market interest rate, EFP is the expectation of future profitability based on optimism or pessimism, CIT represents corporate income taxes, RE represents the retained earnings of firms, CDB is that cost of doing business, and B is the amount of bribes paid when funds are borrowed from the banks. Economic theory suggests that: IIIIII      0,  0,  0,  0, < 0, and  0 (11). r ()()()() EFP  CIT  RE  CDB  B

Next, we consider the supply of loanable funds, which is determined by the willingness of households to save and the extent of government saving (T–G > 0) or dissaving (T–G < 0). When households save, they reduce the amount of goods and services they can consume. Among many factors that influence the level of saving by households, there is also the interest rate received at the banks on their savings. Over the past three decades, remittances from friends and relatives in foreign countries have come to constitute a large portion of the savings that African households have in their banks. This has provided another avenue for corruption within the banking systems in these countries. We can express the private savings function as:

SP = f (r, YD, PIT, REM, B) (12), where SP is private savings, r is the interest rate, YD is the amount of disposable income, PIT is personal income taxes, and REM is the amount of remittances from foreign countries, B is the bribes paid by savers in their transactional dealings with the banks. Again, economic theory suggests that:

12 Central Bank Journal of Law and Finance, No. 1/2017 Oluwole Owoye

SSSSS     PPPPP0,  0,  0,  0, and  0 (13). r ()()() YD  PIT  REM  B

In countries worldwide, aggregate savings (S) is the sum of private savings (SP) and government savings (SG), and it is important to note that SG being positive or negative depends on the fiscal budget positions of the government. Algebraically, we express the aggregate savings (S) as:

S = SP + SG (14).

Economic theory suggests that saving must equal investment, that is:

S = I (15).

Figure 4 shows the aggregate saving supply curve to be upward sloping while the investment demand curve is downward sloping. In efficient market systems, the equilibrium interest rate r* and quantity of loanable funds LF* (or S* = I*) will be determined at the intersection of both curves.

In corrupt financial systems such as those in African countries where financial intermediaries demand and accept bribes from borrowers in loan transactions and from savers in deposit transactions when they receive remittances from their relatives in foreign D S countries, the investment demand curve I 1 and the saving supply curve S 1 shift backward D S D S to I 2 and S 2, respectively. At the new intersection of I 2 and S 2 curves, the quantity of loanable funds decreases from LF* to LF** (or S** = I**), and the market interest rate remained unchanged at r*. At the new LF** and unchanged r*, this means that borrowers pay rBorrowers – r* as bribes when they apply for loans to invest in new investment projects or business expansions while r*– rSavers is the net return to savers when they pay bribes on their saving deposits especially when clearing their foreign remittances with the banks. The shaded area of Figure 4 shows the deadweight loss caused by corruption in the financial systems in African countries while the area (rBorrowers– rSavers) times LF** is the corruption revenue to bank managers.

Central Bank Journal of Law and Finance, No. 1/2017 13 The Analysis of Corruption and Economic Growth in African Countries

Figure 4: The Effect of Corruption in the Loanable Funds Markets

3.5. The Effects of Corruption on the Aggregate Economy In this section, the main objective is to show the negative effects of corruption on steady state per- capita income (Y/L), capital-labour ratio (K/L), and saving per worker (sY/L) in corrupt African countries where it is a common practice for a fraction of the funds earmarked for capital investment to be illegally diverted into personal use or transferred to secret bank accounts in foreign countries. In addition, the analysis is to show that the pervasive corruption is one of the reasons why African countries are on a different growth path despite the implementation of the World Bank and International Monetary Fund reforms (such as the Structural Adjustment Programs of the 1980s). To accomplish this objective, we utilize the neoclassical growth model of Solow, Swan, Meade, and Uzawa5. The production function generally used in the neoclassical model is the aggregate, homogeneous production function of the Cobb-Douglas' type. This is expressed in the form:

α 1-α Yt = AtK L , 0 < α < 1, and 1 – α + α = 1, (16),

14 Central Bank Journal of Law and Finance, No. 1/2017 Oluwole Owoye

where Yt is the gross domestic product, K and L are the aggregate capital stock and labour 6 respectively, and At is the residual growth factor in period t. Equation (16) states that gross domestic product depends on a geometric weighted average of K and L, with weights α and 1– α representing the shares or elasticities of K and L with respect to gross domestic product. To bring the main thesis of this paper into focus, it is important to highlight some of the salient features of the neoclassical growth model. First, the centrepiece of the neoclassical growth model is the steady state equilibrium where the rates of growth of output (ΔY/Y = y*), capital stock (ΔK/K = k*), and the labour force (ΔL/L = n*) are equal, that is, y* = k* = n*. Second, another important feature of this model is that aggregate saving is equal to gross private domestic investment as indicated in equation (15) and illustrated in Figure 4. Third, a constant fraction (s) of the gross domestic product saved (St) is assumed to be invested (It), and this can be expressed as:

St = sYt = It = dKt/dt, and 0 < s < 1 (17). Basically, equation (17) shows that capital stock is an integral part of capital investment. This means that sYt saved is invested thus raising the level of capital stock from period to period.

The gross domestic investment (It) in equation (17) is composed of net investment (IN=ΔK), which is the net addition to capital stock, and depreciation or capital consumption allowance (IR=δK). The capital consumption allowance is assumed to be a fraction (δ) of the total capital stock. In other words, gross domestic investment in period t can be stated as:

It = IN + IR  It = ΔK + δK (18).

Since St = It, and capital stock is an integral part of investment, St can be expressed in terms of K, and ΔK can be rewritten as KΔK/K and then substituted into equation (18). Rearranging terms, the steady state equality of total saving and gross domestic investment is expressed as:

St = sYt = (ΔK/K + δ)K, = (k* + δ)K (19). Dividing both sides of equation (19) by K yields the steady-state aggregate saving per capital stock. Since n* = k* at steady state, therefore, this relationship is expressed as: S/K = sY/K = n* + δ (20). To derive the steady state saving per worker, the per capita production function is introduced into equation (20) by multiplying both sides by K/L. This yields the aggregate saving per worker as: S/L = sY/L = (n* + δ)K/L = (n* + δ)k = sf (k) = (n* + δ)k (21),

Central Bank Journal of Law and Finance, No. 1/2017 15 The Analysis of Corruption and Economic Growth in African Countries where k = K/L. Equation (21) shows the equality between saving per worker and investment per worker at steady-state. This steady-state is shown in Figure 5 where output per worker y* and capital per worker k* grow at the same rate. Now, to show the negative effects of corruption on steady-state for African countries, the production function given in equation (16) is re-specified as:

Y = A[(1-X)K]α(1-v)L(1-α), 0 < α, v, and X < 1 (22). Unlike in equation (16), the production function in equation (22) states that gross domestic product depends on a geometrically adjusted weighted average of K and L, with weights α(1-v) representing the adjusted elasticity of gross domestic product in response to changes in corruption-distorted capital, and 1-α is the elasticity of real domestic product to changes in labour. Equation (22) may be regarded as a reduced form economy-wide technology with negative externality. This is the opposite case of the positive externality often employed in the endogenous growth literature (see Romer, 1986; Barro, 1990; and King and Rebelo, 1990). The corruption factors (X and v) in equation (22) measure the double effects of corruption on the level of capital stock. In other words, X is the reduction in capital when bribes are paid to win contracts or finance/fund capital acquisition and v is the decrease in the productivity or share of capital when inferior and inappropriate machines or tools are purchased and used in the production process. Nigeria, Ghana, and the Democratic Republic of Congo (formerly Zaire) provide real-world examples of countries that have purchased and used inferior and inappropriate capital machines or tools due to corruption. For example, about four decades ago, Nigeria imported several luxurious buses from abroad for the transportation of participants in the World Festival of Arts and Culture (FESTAC). These buses were distributed to the states immediately after FESTAC and they broke down shortly thereafter because of mechanical failures and lack of maintenance spare parts. Similar incidents occurred in Ghana and the Democratic Republic of Congo when they imported agricultural machinery from abroad. These examples show that many African countries prefer to import advanced technology, which they cannot easily assimilate and maintain, but doing so provides the opportunity for rent-seeking or corruption behaviour through over-invoicing.7 The basic argument is that corruption reduces the amount of physical capital available for production thus intensifying the extent of capital dilution, therefore, capital-labour ratio declines. In addition, corruption decreases the productivity of capital because of the inferior choices made during capital investment. To show the effects of corruption on economic growth and development, we follow the procedures that yielded the equality between aggregate savings and investment expressed for non-corrupt economies as depicted by equation (19); and for corrupt economies, we rewrite and express it as:

16 Central Bank Journal of Law and Finance, No. 1/2017 Oluwole Owoye s’Y = (n* + δ)(1- X)K (23). It is important to note that s’Y reflects the reduction in aggregate saving due to corruption as depicted by the backward shift in the savings curve shown in Figure 4. The right hand side of equation (23) implies that corruption reduces gross domestic capital investment by (1-X). Dividing both sides of equation (23) by K yields the corruption steady-state savings- capital stock ratio as: (s’Y/K)' = (n*+δ)(1-X) (24). Multiplying both sides of equation (24) by K/L yields the corruption steady-state investment per worker as: (s’Y/L)' = (n* + δ)(1-X)K/L, s’ f (k') = (n* + δ)kC (25), where kC = (1-X)K/L. Equations (21) and (25) show the non-corrupt and corrupt steady-state equilibria, respectively. Both are illustrated graphically in Figure 5 in order to see the effects of corruption on steady-state output per worker and capital per worker. The non-corrupt steady-state indicated by equation (21) shows that sf (k) and (n* + δ)k are equal and the steady-state output per worker and capital per worker are y* and k*, respectively. It is important to note that capital dilution could occur and thus countries could experience divergence from y* and k* if capital and labour do not grow at the same rate, that is, if the growth in the level of investment is not large enough to equip new workers with the same capital available to previous workers. The corrupt steady-state given by equation (25) shown in Figure 5 implies that corruption worsens capital dilution and productivity in African countries because inferior capital goods are used in the production process. In other words, with corruption, the steady-state occurs where s’ f (k') and (n* + δ)kC are equal and capital investment per worker decreases, and thus, capital-labour ratio, steady-state income per capita, and saving per worker decrease from k* to k*C, y* to y*C, and sf (k) to s’f (k’), respectively. This implies that corruption reduces steady-state level of capital per worker, and since capital per worker decreases from k* to k*C, and output per worker also decreases, the living standards in many African countries are lower.

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Figure 5: Non-corrupt and Corrupt Steady-States

4. CONCLUDING REMARKS

In this paper, we have demonstrated the negative effects of corruption on economic growth in the African countries where corruption is more pervasive. The illustrations with the aid of the theories of consumer demand, production and costs, government monopoly, and the neoclassical growth model, we show that corruption reduces domestic consumption of goods and services and thus puts households at lower utility levels. Similarly, we show that business firms operate inefficiently with respect to input mix when they pay bribes to acquire capital in the production process. With the monopoly model, we show that governments in African countries act as self-regulated monopolies through their price control policies and that government officials extract monopoly rents in form of bribes from consumers. With the aid of the neoclassical growth model, we show that corruption lowers the level of steady-state capital stock per worker, investment per worker, and per capita income. In essence, corruption reduces a constant return to scale aggregate production function to a decreasing return to scale. The associated diseconomies of scale contribute to the reduction in the productivity of capital which distorts the optimal combinations of capital and labour. Most significantly, this paper shows that pervasive corruption in African countries is one of the major reasons for their economic backwardness despite many structural reform programs of the 1980s and 1990s.

18 Central Bank Journal of Law and Finance, No. 1/2017 Oluwole Owoye

APPENDIX A

This section presents a simple algebraic analysis of the effects of corruption on aggregate output growth. To do this, we utilize the same production function given in equation (22) in Section 3. That is,

Yt = At[(1-X)K]α(1-v)L(1-α), 0 < α, v, and X < 1 (1A).

We totally differentiate the production function in equation (1A) with respect to time. Assuming that A is constant, this yields, dY/dt = Aα(1-v)[1-X]α(1-v)Kα(1-v)-1L(1-α)(dK/dt) + A(1-α)[(1-X)K]α(1-v)L-α(dL/dt) (2A).

Dividing both sides of equation (2A) by Y yields,

(dY/dt)/Y = α(1-v)[dK/dt]/K + (1-α)[dL/dt]/L (3A), where (dY/dt)/Y = yc, (dK/dt)/K = k*, and (dL/dt)/L = n* are the growth rates of Y, K, and L respectively. Equation (3A) implies that output growth rate, yc, in economies with corruption is the sum of capital's net share, α(1-v), times its growth rate and labour's share, 1-α, multiplied by its growth rate. Since the growth rates of K and L are k* and n*, yc can be expressed as: yc = α(1-v)k* + (1-α)n* = n*(1-αv) (4A).

In non-corrupt economies, X = v = 0, and equation (4A) yields a non-corrupt steady state output growth, ync, as: ync = αk* + (1-α)n* = n* (5A).

From equations (4A) and (5A), it is apparent that ync is greater than yc because α is greater than α(1-v) and n* is also greater than n*(1-αv). Again, this implies that investment per worker, capital-labour ratio, and per capita income in non-corrupt economies would be higher than those in the economies with chronic corruption. This is particularly true for African countries where capital-labour ratio is already very low.

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NOTES

1For a detailed coverage of this, see Associated Press (AP), "Nigerian Skyscraper in Flames," Danbury News-Times, Friday, April 16, 1993, p. 7. 2 For a detailed review of the literature on corruption, see Ades and Di Tella (1999), Jian (2001), Aidt (2003, 2009), Aidt and Dutta (2008) 3It is straightforward to assume that while private firms produce goods and services that are rival and excludable, public enterprises provide public goods and services that are nonrival and nonexcludable. 4Note that ghost/graveyard workers do not contribute to output production. In other words, the marginal productivity (Qt/Lg) is zero. However, the existence of ghost workers is reflected in an increase in the total costs of production. 5For a complete analysis of the neoclassical model, see studies by R.M. Solow, "A Contribution to the Theory of Economic Growth," Quarterly Journal of Economics, Vol. 70 (February 1956), pp. 65-94, and "Growth Theory and After," American Economic Review, Vol. 78 (June 1988); T.W. Swan, "Economic Growth and Capital Accumulation," Economic Record, Vol. 32 (November 1956), pp. 334-361; J.E. Meade, A Neoclassical Theory of Economic Growth (London, George Allen & Unwin, Ltd., 1961); and H.U. Uzawa, "Neutral Inventions and the Stability of Growth Equilibrium," Review of Economic Studies, Vol. 28 (February 1961), pp. 117-124. 6It is important to point out that there is no loss in generality as to the type of the production function used. It could be capital-augmenting or labour-augmenting. For the residual growth factor, see R.M. Solow, "Technical Change and the Aggregate Production Function," Review of Economics and Statistics, Vol. 39 (August 1957), pp. 312-320. 7See Shleifer and Vishny, "Corruption," Quarterly Journal of Economics (August 1993), pp. 613-614, for similar examples with respect to Mozambique's bottle-making factory.

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REFERENCES

1. Ades, A., and R. Di Tella (1999), “Rents, Competition, and Corruption,”. American Economic Review, 89, 982-993. 2. Aidt, T. S. (2009), “Corruption, Institutions, and Economic Development,” Oxford Review of Economic Policy. 25, 271-291. 3. Aidt, T. S. (2003), “Economic Analysis of Corruption: A Survey,” The Economic Journal, 113, F632-F652. 4. Aidt, T. S., and Dutta (2008), “Policy Compromises: Corruption and Regulation in a Democracy,” Economics and Politics, 20, 335-360. 5. Andvig, J. C. (1991), “The Economics of Corruption: A Survey,” Studi Economici, 43, 57-94. 6. Ayittey, G. (2012), “Defeating Dictators,” Speech given at the Oslo Freedom Forum, 2012. Retrieved from http://www.oslofreedomforum.com/speakers/george_ayittey.html on May 24, 2012. 7. Ayittey, G. (2011), “War on African Dictatorships,” Ethiopian Review. Retrieved from http://www.ethiopianreview.com/content/33222 on May 24, 2016. 8. Ayittey, G. (2002), “Biting Their Own Tails: African Leaders and the Internal Intricacies of the Rape of a Continent,” A keynote address at the International Conference of the Society of Research on African Cultures (SORAC), November 7-9, 2002, New Jersey. Retrieved from http://www.sorac.net/site/2002/11/sorac-2002- keynote-speakers-ali-mazrui-george-ayittey on May 24, 2016. 9. Bardhan, P. (1997). Corruption and Development: A Review of Issues. Journal of Economic Literature, 35, 1320-1346. 10. Bissessar, N. (2009). Does Corruption Persist in Sub-Saharan Africa? International Advances in Economic Research, 15, 336-350. 11. Associated Press (1993), "Nigerian Skyscraper in Flames," Danbury News-Times, Friday, April 16. 12. Banfield, Edward (1975), "Corruption as a Feature of Government Organization," Journal of Law and Economics, XVIII , 587-605. 13. Barro, Robert J. (1990), "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, 98, S103-S125. 14. Beenstock, Michael (1979), "Corruption and Development," World Development, 7, 15-24. 15. Deacon, R.T and J. Sonstelie (1989), "Price Control and Rent-Seeking Behavior in Developing Countries," World Development, 17, 1945-1954. 16. Devarajan, S., C. Jones, and M. Roemer (1989), "Markets under Price Controls in Partial and General Equilibrium," World Development, 17, 1881-1893. 17. Ekpo, A.H. and T. Agiobenebo (1985), "Corruption and Prices: A Theoretical Note," Nigerian Journal of Economic and Social Studies, 27, 305-316. 18. Jain, A. K. (2001), Corruption: A Review,” Journal of Economic Survey, 15, 71-121.

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19. Johnson, Omotunde E. G. (1975), "An Economic Analysis of Corrupt Government with Special Application to Less Developed Countries," Kyklos, 28, 47-61. 20. King, Robert G. and Sergio Rebelo (1990), "Public Policy and Economic Growth: Developing Neoclassical Implications," Journal of Political Economy, 98, S126-S150. 21. Krueger, Anne O. (1974), "The Political Economy of the Rent-Seeking Society," American Economic Review, 64, 291-303. 22. Lawal, G (2007), “Corruption and Development in Africa: Challenges for Political and Economic Change,” Humanities and Social Sciences Journal, 2, 1-7. 23. Lui, Francis T. (1985), "An Equilibrium Queuing Model of Bribery," Journal of Political Economy, 93, 760-781. 24. Lui, Francis T. (1986), "A Dynamic Model of Corruption Deterrence," Journal of Public Economics, 31, 215-236. 25. Meade, James.E. (1961), A Neoclassical Theory of Economic Growth (London: Unwin Ltd.). 26. Owoye, Oluwole and Ibrahim Bendardaf (1996), “The Macroeconomic Analysis of the Effects of Corruption on Economic Growth of Developing Economies,” Rivista Internazionale di Scienze Economiche e Commerciali (International Review of Economics and Business), 43, 191-211. Reprinted as Chapter 35, Volume I of The Economics of Corruption and Illegal Markets, Gianluca F., and Zamagni, S., eds. United Kingdom: Edward Elgar Publishing, 1999. 27. Owoye, Oluwole and Nicole Bissessar, (2014), “Corruption in African Countries: A Symptom of Leadership and Institutional Failure” in Challenges to Democratic Governance in Developing Countries, edited by Gedeon M. Mudacumura and Göktug Morçöl (Springer Publisher) 28. Rose-Ackerman, S. (1975), "The Economics of Corruption," Journal of Public Economics, 4, 187-203. 29. Rose-Ackerman, S. (1978), Corruption: A Study of Political Economy (New York: Academic Press). 30. Romer, Paul M. (1986), "Increasing Returns and Long-Run Growth," Journal of Political Economy, 94, 1002-1037. 31. Shleifer, Andrei and R. W. Vishny (1993), "Corruption," The Quarterly Journal of Economics (August), 599-617. 32. Solow, Robert M. (1956), "A Contribution to the Theory of Economic Growth," Quarterly Journal of Economics, 70, 65-94. 33. Solow, Robert M. (1957), "Technical Change and the Aggregate Production Function," Review of Economics and Statistics, 39, 312-320. 34. Solow, Robert M. (1988)., "Growth Theory and After," American Economic Review, 78 35. Swan, T. W. (1956), "Economic Growth and Capital Accumulation," Economic Record, 32, 334-361. 36. Uzawa, H. U. (1961), "Neutral Inventions and Stability of Growth Equilibrium," Review of Economic Studies, 28, 117-124

22 Central Bank Journal of Law and Finance, No. 1/2017

Republic of Moldova: First-Wave Reform of Security Interests Legal Framework

Roger Gladei* Patricia Handraman** Roger Gladei* Patricia Handraman**

Abstract

Stakeholders ought to conduct secured transactions under the auspices of an effective and foreseeable law. The legal rhetoric of the new amendments to the security interests laws capture this underlying endeavour by demystifying a number of legal concepts, notably that of pledge over funds in bank accounts. The amendments also further the legal regime of the pledge over receivables, proceeds of disposition, subsequent pledge, and introduce new self-help enforcement measures. This piece analyses the reasons that propelled the legislative swooping in, amongst which fall, notably, the paucity of the movable pledge use in securing debtor’s obligations, the lack of a cogent rationale for having numerous Registers in force for pledge registration and the readily obtainable annulment of enforcement procedures.

Keywords: Republic of Moldova, collateral, international best practice, financial sector, law-making, World Bank, goods, enforcement, self-help, deposit, bankruptcy, Charge Registry, business sector, reform

JEL Classification: K22, G21

* Managing Partner, Gladei & Partners; attorney-at-law. Professor at the National Institute of Justice (Republic of Moldova). ** Junior Associate, Gladei & Partners; trainee-attorney-at-law.

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1. INTRODUCTION

A 2010 World Bank Report1, issued after the consultation of government authorities, private sector stakeholders and market participants, found that “[w]hile the secured transactions framework in Republic of Moldova is generally sound, significant loopholes and weaknesses remain.”2 Concurrently, 39 per cent of firms identified access to finance as a major constraint, and many of them suffered from little or no access to external financing.3 Consequently, the great bulk of firms relied upon retained earnings to compensate some of their inability to gain access to affordable credit to finance their activities and growth.4 Novel and innovative approaches to legal issues could single-handedly reshuffle financial institutions’ outlook on movable collateral, which in consequence would influence corporate sector’s growth. For a glimpse into the role of the movable collateral in the financial sector in Republic of Moldova, consider that, in 2010, it was composed of 15 active banks with total assets of around 39.3 billion Lei,5 out of which 19 billion Lei in loans.6 As of December 31, 2013 total assets value increased to 76 billion Lei, 31.0% more as compared to the end of 2012, and indicated a persistent trend of banking-activity expansion.7 As a result of the recent turmoil in the Moldovan banking system and of the bankruptcy of 3 banks, in 2017, the total assets of the banks constitute 75 billion Lei with 34.2 billion Lei (45.6 per cent of the total assets) in loans.8 A banking sector survey conducted prior to the passing of the legal reform amendments concluded that the immovable collateral spanned 51 per cent (in land, commercial and residential assets) of the total collateral;9 by contrast, only 18 per cent of the total collateral constituted movable pledge.10 This chasm pointed to a number of social inequities best explained by the tenet according to which most laws influence, to a greater or lesser degree, human lives;11 this holds perhaps truer in the case of loan related regulations. The hegemony of immovable over movable collateral translated into the fact that those who did not own immovable properties were virtually thwarted from substantive lending,12 which made their business-growing endeavours slippery at best. Thus, the stance of the Moldovan lawmaker was bound to flit erstwhile dogmas and resurrect economic equity. As a matter of modern socio-economic policy, one need not necessarily own immovable properties to secure affordable financing. An opposite calculus would carry the ungainly consequence that wealthiness equals, is brought by or relates to immovable property. In Republic of Moldova, the transformation has gained momentum in 2014 when lawmakers enacted the Law on Amending and Supplementing Certain Legislative Acts No. 173 dated 25.07.2014 (A173), which substantively altered the Law on Pledge No. 449- XV of 30.07.2001 (P449) and a number of related laws, notably Tax Code No. 1163 of

24 Central Bank Journal of Law and Finance, No. 1/2017 Roger Gladei, Patricia Handraman

24.04.1997 (T1163), Enforcement Code No. 443 of 24.12.2004 (E443) and Law on Capital Market No. 171 of 11.07.2012 (C171). A173 tackled a panoply of legal issues, among which reducing the costs of creating security, avoiding the duplication of registrations in different Registries (e.g. vehicles), introducing effective self-help measures, expediting enforcement procedure and imposing penalties for abuse or misuse of collateral etc. A173 introduced new kinds of pledges with the objective to bolster stakeholder’s reliance on movable pledge and fit new demands. Internationally, Germany and Japan are good examples of jurisdictions to allow more extension on the kinds of security that can be created and on the manner in which it can be enforced.13 On the other side, France, Italy, Spain, and a number of Latin American countries have been less permissible.14 Lastly, policymakers consequentially debated the bipolar paradigms for the moment of creation of pledge; here, as we develop in the respective Section, lawmakers departed from international best practices. The research question of this piece concerns the way in which A173 influenced the financial and the business sector. This question subdivides in a set of post-amendment reflections: what was the intent of the amendments? Did the amendments provide effective answers to key concerns? Is there congruity between legislative intent and practice? Section I of this piece provides a brief background necessary for a better understanding of the context of this topic. The remainder of this piece will discuss overarching issues and will untangle a number of questions related to the practicalities of each of them.

2. BACKGROUND

In contrast to other jurisdictions,15 the possessory and non-possessory pledge dichotomy has pervaded the Moldovan legal system since the institution’s outset; any movable or immovable, tangible or intangible goods can be object of the pledge.16 For illustration, stocks of goods, equipment, installations, agricultural machinery, a deposit certificate, warrant or bill of lading can be object of a pledge.17 As Professor Lévy explains, the pledge is a double-facet institution. That is, if the debt is outstanding, the secured goods guarantee repayment, whereas, if the debt has been repaid, the creditor has a restitution obligation.18 In the beginning, the guarantee key feature of the pledge was only conferred by the ius possidendi right of the creditor.19 The possessory pledge – in many jurisdictions known as pawn – was acclaimed for its inherent constraining factor; the possessing creditor was barred from using, disposing or enjoying the fruits of the pledged goods.20 In some cases, creditors and debtors would negotiate a clause that enabled the creditor to enjoy the fruits in exchange for an interest- duty exemption.21

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Over time, creditors have become cognizant of the positive economic impact entailed in permitting debtors to preserve possession of the encumbered assets. As it is in the interest of the creditors too that their debtors be economically prosperous, notably to enable a timely loan repay, a non-possessory pledge has taken the reins of modern arrangements. Remarkably, the “pledge” term that P449 operates with substantially differs from the “ordinary pledge.”22 Most commonly, foreign jurisdictions that have enacted similar laws to that of P449 use the “pledge” term to refer to security rights arising from possessory movable assets, by dispossessing the debtor of the encumbered asset.23 For illustration, in English law a “mortgage” transfers the property to the creditor, a “pledge” security right confers the possession of the secured assets, and a “charge” gives the creditor the right to seek indemnification in court, in the case of debtors’ default.24 In our legal system, the “pledge” is twofold. On the one hand, the “pledge” is probably situated somewhere in between the English “pledge” and “charge.” That is, a pledge can be either non-possessory (most commonly) or possessory, the former permitting the debtor to continue enjoying the possession of the secured assets. In case of default, upon receipt of the enforcement notice, the debtor shall convey to the creditor the possession of the secured assets, subject to several legal solutions available to the creditor.25 On the other hand, the term “pledge” has a rather generic meaning, employed to refer to all types of securities, including the possessory and non-possessory movable pledge and the immovable pledge (mortgage).26 Notoriously, regulations and judges alike use the term “pledge” to refer generally to all kinds of securities.27 Notwithstanding the terminological integration, the immovable pledge (mortgage) is subject to a different regulatory framework,28 thus P449 is applicable in a complimentary fashion only.29 For this reason, mortgage will not be subject of discussion in this piece. There are two prominent readily discernible policy features in the new amendments. On the one hand, A173 augments secured transaction numbers by employing a transaction- flexibility approach. That is, it allows the grantor and security creditor a significant margin to tailor security arrangements in ways that best suit their pursued interests.30 For instance, grantors can pledge their funds on bank accounts31 to the benefit of their secured creditors while retaining the disposition of the funds therein (non-possessory pledge). Mandatory rules are set forth to regulate overarching areas – occupying thus the role of a sentry to public order – such as the form of the security agreement, the moment of pledge creation and priority, and object of security rights. On the other hand, the “weak-party protection” policy sequentially shifts sides to benefit both the grantor and the secured creditor. It is, therefore, more a matter of time situation that makes such protection available to each side of a security agreement than the contractual quality per se. Specifically, P449 affords increased protection to the grantor at the moment of conclusion of the security agreement, and, respectively, to the secured creditor upon

26 Central Bank Journal of Law and Finance, No. 1/2017 Roger Gladei, Patricia Handraman grantor’s default. For instance, the provision that allows the grantor to negotiate the non- extension of the pledge over insurance indemnities, proceeds, and accessory assets is favourable to the grantor and is situated in time at the conclusion of the contract. On the contrary, the provision that allows the secured creditor to request early performance is ostensibly in the secured creditor’s benefit. The rationale of this protection shift is that it is not always easily determinable who the weak party of a pledge agreement is. This might depend on a number of factors, notably time situation and specific market conditions such as demand and supply ratio etc. Overall, the purpose of the reform was to increase access to credit by (i) expanding the type of assets which can constitute the object of movable charges; (ii) expanding the regime of publicity and priority among creditors, beyond the movable pledge, to other financial instruments with a similar purpose, including the financial leasing; (iii) improving the protection of commercial interests of both creditors and pledgors, by striking an adequate balance of interests; and (iv) streamlining the process of recovery of secured loans to prevent bottlenecks at the stage of enforcement and encourage creditors to accept movable charges to a larger degree.32 Moreover, a number of concerns were addressed, particularly referring to (i) the lack of a cohesive mechanism to obtain input VAT credit on the purchase of the pledged asset within enforcement – in cases where the pledgor refused to issue a tax invoice to the buyer; (ii) the risk of fraudulent transactions involving secured assets, following the decriminalization of the sale of the pledged assets without creditor’s consent; (iii) disuse of certain types of movable pledge (enterprise pledge) or under-use thereof (notably the pledge of body of assets and pledge of receivables had scarcely been the object of a security agreement); and (iv) the impossibility of registering security rights of concurring secured creditors.33 These reasons single-handedly justified the amendment of P449, for they posed a serious risk of imperilling the efficiency of secured transactions. Systemic legal problems that required special attention referred to (i) object and scope of pledge, (ii) creation of the pledge and publicity, (iii) subsequent pledge, and (iv) enforcement.

3. OBJECT AND SCOPE OF A173

As Lévy judiciously observes, goods change – what could undoubtedly serve as attractive pledge at one point in time, loses its flashiness to later creditors.34 In the original version of P449 (2001), the secured transactions framework fostered the advent of innovative pledges, among which future assets and the pledge on a body of assets.35 Despite those innovations, certain pledges contained vague and misguiding language that made the legal regime thereof unclear.36 Thus, the most important challenges A173 was called on to give answers to were the pledge on funds in accounts37 (2.1., below), the pledge on receivables (2.2., below), and the proceeds of disposition of a pledged asset (2.3., below).

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3.1. Pledge on Funds in Bank Accounts The concept of pledge on funds in bank accounts38 was first introduced in the secured transactions framework in 2012.39 At that time, the concept was rather confusing, notably due to the fact that it could only be constituted by way of dispossession. As noted above, secured creditors became increasingly mindful of the fact that dispossessing the clients of their assets (i.e. funds) shackled their activity, which in turn negatively influenced the debtors’ repayment capacity. Additionally, lawmakers observed that funds in accounts are rights and not things, thus the pledge thereon ought to be non-possessory, and not possessory.40 Considering these reasons, it follows that the pledge on funds in accounts would have remained void of meaning had A173 not changed its course by stipulating the non-possessory pledge as an alternative. A173 affects the pledge on funds in accounts in a number of ways. First, it untangles certain aspects of the bank’s right to set-off and the confidentiality obligation in relation to prior pledges.41 Second, it enlarges the scope of pledge over future money introduced in the bank account. Finally, it consecrates increased protection for the secured creditor. The latter measure was galvanized by an urge to allay enforcement-related concerns and thus made the pledge on funds in bank accounts a reliable security to the creditors.42 Consider this: Where the security right is a tangible movable asset, creditors dispose a vast array of protection measures, including (i) the right to follow the pledged asset into the hands of transferees; (ii) the creditors’ rights automatically expanded on the replacement assets or equivalent compensation persist in the event of goods’ transformation, extend to the goods resulted from the union of several movable assets, some of which have been pledged, except when derogation is permitted; and (iii) the person acquiring the ownership of the secured assets is accountable to the secured creditor, if the secured creditor has not consented to the transfer. In the case of pledge on funds in accounts, none of the above measures is applicable. So, what protection measures could effectively respond to a creditor’s reasonable expectations of legal protection? The response of lawmakers was to introduce a new tool – the control agreement.43 The control agreement has two functions. First, it is a protection measure in case of pledgor’s default. Second, it is a tool that ensures third-party effectiveness.44 That is, the control agreement need not be registered in the Registry of Charges of Movable Assets (Charge Registry). Its effectiveness against third parties is ensured by the creditor’s control over the account, including the current accounts45 and the deposit accounts46. In the case of the subsequent pledge, priority is determined by reference to the moment of the conclusion of the control agreement. The lack of formalism, in this case, might result costly and cumbersome, since it requires tripartite negotiations to enter into a control agreement.47 Nonetheless, there is a major benefit to this, namely that the pledge made public by way of the control agreement gives the secured creditors the privilege to effect their rights with preference over secured creditors who made their

28 Central Bank Journal of Law and Finance, No. 1/2017 Roger Gladei, Patricia Handraman pledge rights public by way of registration.48 Some argue that although the control agreement is not as transparent a method of publicity as registration in the Charge Registry, this does not worsen the already disadvantageous position that third parties occupy.49 This kind of pledge can be established in favour of the depositary bank, a third bank or a non-banking creditor. The control agreement is either a tripartite agreement concluded between the depositary bank, the pledgee and the pledgor, or a bilateral agreement if the pledgee is the depositary bank itself, whereby the bank where the account is opened undertakes certain obligations toward the pledgee.50 If the debtor is acting in bona fides51 – that is, repays the loan as set out in the repayment schedule –, the purpose of the control agreement is reduced to the monitoring function. On the contrary, if debtors default on their obligations under the control agreement, the secured creditor will have priority to the account’s funds with preference to other creditors. Typically, the account holder is free to dispose of the funds in account until the default occurs. However, the parties may agree to limit or withdraw the access of the account holder to the account where there are economic reasons to do so. Instituting a pledge on the account’s funds has a number of advantages and disadvantages. From the pledgee’s perspective, there are several advantages, namely that (i) typically, the creditors receive a first-priority pledge that entitles them to claim their rights with preference over other creditors; (ii) the secured creditors may ask for early enforcement if other creditors counterclaim it; (iii) if the bank fails to notify the secured creditor of any counterclaims, the bank may be held responsible for damages; (iv) it is a means of collecting the indemnification due to the debtor; that is, in case the same secured creditor has concurrently created a pledge on other kinds of pledges (e.g. has created a pledge over pledgor’s funds in accounts and vehicle) and if the other kind of pledge has been damaged and indemnities are due to the pledgor, the secured creditor will be entitled to ask that the due indemnities be paid to account,52 which will be encumbered in the favour of the secured creditor within three days of the request, subject to an “early performance” sanction. Downsides, from the pledgee’s perspective, are (i) the prevalence of the bank’s right to set off renders inefficient any contractual clauses that stipulate otherwise; (ii) under the law, the debtor does not own indemnities if the bank effects its set-off right (thus a contractual provision is highly recommended); (iii) since this kind of pledge does not require registration, the lack of possibility of obtaining, from an entrusted authority, a list of persons that could potentially counterclaim or raise concerns (thus a condition precedent requiring that the pledgor obtain from the depositary bank a document (form of acknowledgement) stating that no other pledges on the funds in accounts, to their knowledge, exist, is highly recommended). From the pledgor’s perspective, it affords the benefit of enjoying the possession of the funds, unless the parties have agreed otherwise.53

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A173 indicates that upon receipt by the depositary bank of the enforcement order issued by the pledgee (that is, if the pledgee is other than the depositary bank), the bank shall refuse to execute the pledgor’s orders on debiting the funds, if after such charging the account’s balance will be reduced below the balance of the secured obligation indicated in the enforcement notice.54 With respect to the latter, if the bank breaches its obligation not to execute the pledgor’s orders, it will be jointly liable for the damage caused to the pledgee.55 As mentioned above, A173 provides priority to the depositary bank’s right to set off.56 Noticeably, even after the amendments, P449 does not generally regulate the set-off.57 Having entrenched roots in many jurisdictions,58 the set-off right entitles the depositary bank to set off any debtor’s obligations towards it in preference to the rights of other creditors of the grantor, whether secured or unsecured.59 There is a sharp distinction between a pledge right over funds in accounts and the right to set off that arises under the law. The latter is not a security right, and thus it is not subject to any public registration requirement.60 The right to set off and the pledge right in favour of the depositary bank are analogous in their effects;61 the distinction thereof lies in the enforcement procedure. Thus, in the case of a set-off right, a bank will enforce its rights against the debtor when it has a counterclaim of the same nature that is certain, liquid, and due; by way of declaration sent to the debtor.62 In the case of a pledge on funds in accounts, a bank will enforce its rights by way of an enforcement notice.63 Upon enforcement, if the currency of the guaranteed obligation and the currency of the money in the bank account are different, the bank will have the right to exchange the money received in the currency of the guaranteed obligation by extinguishing the equivalent amount of the secured debt at the official rate of the National Bank of Republic of Moldova, at the time of debiting the account.64 In the wake of the communication of the respective documents, the effects of both institutions are similar – obligation enforcement. Comparatively, in Germany, the pledge on account funds encumbers all present and future rights arising against the depositary bank. The pledge is created by a simple agreement and will not be effective unless the depositary bank has been notified thereof. Such agreement may prohibit the pledgor to make withdrawals from the account in the ordinary course of business. In France, the pledge only extends over the credit balance, be it temporary or permanent; execution is subject to account adjustment operations, according to the enforcement procedure. In Croatia, it is possible to encumber funds in accounts although the law does not expressly set forth in what manner (provisions concerning movables apply where reasonable). Consequently, the pledge on account funds can only be enforced by voluntary submission to enforcement; that is, where the debtor agrees to encumber funds in accounts, it must provide a statement in the form of a notarial deed authorizing the depositary bank to enforce the available amount in its bank accounts. Non-judicial enforcement on bank accounts is possible via a decree issued by a public notary.

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3.2. Pledge on Receivables At the origins of this pledge there is a personal right, as contrasted to in rem rights – a distinction that did not enjoy a safety harbour from scholarly critique.65 Some argue that personal and in rem rights overlap; that is, any personal right is the outcome of the application of a thing to the patrimony of a person.66 The tenet is simple. What matters, in the view of scholars, is not the person that has the undertaking, but the goods that are subject to such undertakings.67 The opposing doctrine argues that, although personal and in rem rights are somewhat similar, the distinction cannot be overlooked since creditors can only claim their rights by addressing them to an individual person.68 Nonetheless, it is important to maintain the distinction between personal rights and in rem rights, as they enjoy different juridical regimes.69 To apprehend the impact of A173 in this domain it is helpful to observe that Section 4 subsection 3 which was entitled “Particularities of pledge on receivables” and contained two provisions: (i) the obligation of registration and (ii) encumbering receivables, became “Particularities of pledge on intangible goods” and regulates, inter alia, patrimonial rights which can be any property rights, including intellectual property rights, money claims, other contractual claims, and claims arising from other grounds of liability, with the exceptions provided by law.70 One provision that has remained intact is that any patrimonial right can be subject to this pledge, including the pledgor's claim against the pledgee. An audacious amendment involves that encumbering receivables does not require the consent of the debtor of the patrimonial obligation; this is also a beneficial amendment on at least three accounts.71 First, any receivable is part of creditor’s assets, thus they should be able to freely dispose thereof. Second, the hectic nature of business transactions requires timely resolutions that would be hindered by negotiations with third parties (the debtor). Finally, a potentially unjustified negative notice from the debtor would amount to shackling creditors’ business transactions in an arbitrary fashion. The way this kind of pledge works is simple. The debtors of the patrimonial obligation (obligors) carry on the repayment to the creditor (pledgor) according to contractual terms, until they receive an enforcement notice from the pledgee stating that the creditor whom they’ve been repaying has defaulted on its obligations under an agreement with the pledgee. Upon receipt of the enforcement notice, the obligor will continue the payment according to the instructions of the pledgee only, subject to the payment of indemnities. Intuitively, the pledgee will require that the obligor reverse the payment to its benefit. In this case, for purposes of avoiding over-charging, the pledgee shall inform the obligor of the amount of the secured obligation. If the contractual obligation is not a cash receivable (e.g. delivery of goods), the obligor will perform its obligations in accordance with the pledgee’s indications, especially those regarding place and date of delivery. If there is no

Central Bank Journal of Law and Finance, No. 1/2017 31 Republic of Moldova: First-Wave Reform of Security Interests Legal Framework determined term for performing the obligation or if it does not arise from its nature, the obligor shall perform the obligation within 7 days from the pledgee's request, if immediate performance does not result from the law, contract or nature of the obligation. It is noticeable that upon receiving the enforcement notice (i) any changes of the performance conditions, made without the pledgee's consent, are deemed null; (ii) the pledgor’s acts in connection to the performance or enforcement of the rights with respect to the secured obligation, made without the pledgee's consent, are invalid. During this process, any goods received by the pledgee will be deemed encumbered by pledge, which renders the enforcement rules under Chapter VIII of P449 applicable. Thus, any goods that the pledgee has received are to be directed towards the extinction of the pledgor’s debt. If the pledgee seeks enforcement in Court, it shall ensure that the debtor is part in the litigation. Additionally, A173 provides that pledging receivables is valid and enforceable even if the debtor and the pledgor have included a contractual restriction that prohibits disposition thereof. This amendment pinpoints to the pro-business orientation of A173 and is a key feature that assigns maximum value to patrimony as a means to secure business transactions. Moreover, if the security agreement does not provide otherwise, the pledge on receivables extends to any personal or real security interest of the pledged receivables. Banca de Finanțe și Comerț v. Victoriabank72 indicates that (i) the pledgor cannot assign a receivable without the pledgee’s consent, subject to nullity, and (ii) if the secured creditor has assigned the receivable to a third party (upon pledgors’ default), the third party shall have received, with the receivable, all the rights arising out of the pledge agreement. In this case, Banca de Finanțe și Comerț and X concluded a loan agreement; X secured the loan by pledging receivables from Y. Upon X’s default, Banca de Finanțe și Comerț sold the receivables to A; later on, X sold the same receivables to Victoriabank. The first instance Court judgment quashed the assignment concluded between X and Victoriabank and dismissed the plaintiff’s motion to enter into possession of the pledge. The Appellate Court upheld the judgment by motivating, inter alia, that the receivables and the pledge thereupon may only be transmitted together and simultaneously, thus it is A who is entitled to enforce on the receivables.

3.3. Proceeds of Disposition of a Pledged Asset and Fruits The importance of this revision in A173 is highlighted by situations where the debtor disposes of the pledged assets before redemption occurs. In this regard, A173, alongside with other legal systems,73 distinguishes between (i) replacement assets, (ii) civil and natural fruits, (iii) proceeds of disposition, and (iv) indemnities. For instance, where in the ordinary course of business the pledgor sells a part of the pledged body of assets (replacement assets), expropriation has occurred (indemnities), the secured creditor has

32 Central Bank Journal of Law and Finance, No. 1/2017 Roger Gladei, Patricia Handraman consented a sale of assets (proceeds of disposition), the offspring of animals (natural fruits). The rule preceding A173 was that security rights do not extend to civil or natural fruits, or proceeds unless otherwise provided by the parties in a security agreement. A173, recasting the rule’s angle to fit economic actualities, adopted a more inclusive approach. The new law forthrightly states that security rights in an asset automatically span over its proceeds, unless otherwise agreed by the parties of the security agreement. Although this provision does not grant new rights, it emphasizes the logic of asset encumbering: a security right in an encumbered asset should extend to its civil and natural fruits, unless otherwise decided by the parties. Albeit this conversion, arguably it is still uncertain if secured creditors can claim rights over proceeds of proceeds, for instance, the progeny generated by the offspring of a pledged animal. A173 takes the position of UNCITRAL in this matter, namely that if a secured creditor can claim rights in the proceeds of a secured asset, it would logically follow that they can claim rights in proceeds of proceeds.74 Even if we believe the above logic to be implicitly stated in the law, there is still some space for the argument that, to prevent misinterpretation, the principle shall be expressly regulated by the law. Creation of the Pledge and Publicity The reason why we treat the creation of the pledge and publicity together in this Section is the interconnection between the two concepts. The publicity of the movable pledge – given by the registration in the Charge Registry – determines the creation of the rights arising from a security agreement.75 Pledge registration has a number of functions. First, as contended above, the pledge registration in the Charge Registry determines its creation; corollary, the pledge is not created by way of concluding a security agreement.76 Second, it enables prospective creditors to learn about the pledged assets of a potential pledgor. Finally, it is the regular way of establishing priority amongst secured creditors (i.e. except cases of control agreements for the pledge on funds in accounts). International best practices point that modern secured transactions regimes should determine priority by reference to objective facts (such as registration of a notice, possession, a control agreement and a notation on a title certificate).77 The rationale for this rule is based on the premise that it is often difficult to prove that a person had knowledge of a particular fact at a particular time.78 To adopt this practice, A173 provides the creation of a special single Registry – wherein registration, as set forth – hinges upon “simplicity, efficiency and accessibility.”79 To understand why this is a revolutionary amendment requires some background. As a matter of fact, before the enactment of A173, there were four Registries in Republic of Moldova where the movable pledges were recorded, namely (i) the Nominative Securities Holders Registry – in the case of pledge on nominative securities; (ii) the State Securities Holders Registry – in the case of pledge on state securities; (iii) the Intellectual Property

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Registry – in the case of pledge on intellectual property rights; and, finally (iv) the Movable Pledge Registry – in the case of other movable pledges.80 A173 provided that there would be one centralized Registry, namely the Registry of Charges of Movable Assets.81 In the Charge Registry there are currently registered movable security interests, including financial leasing and, as the civil law reform progresses, the unpaid seller’s charge and others.82 We believe that this amendment is especially clarity-oriented since the registration of pledges, in the old version of the P449, had to be carried out in accordance with the legislation governing each Registry.83 Notably, international best practices recommend that States adopt a single Registry that accommodates all kinds of movable pledges, including the existing or potential rights and excluding pledges on documents.84 To further this concept, A173 set forth that the technical accommodation and procedure of pledge registration be provided in a distinct normative act approved by the Government.85 Subsequently, the Government passed a Regulation on Charge Registry No. 210 of 26.01.2016. Moreover, it is recommended that States adopt systems which provide that, except limited situations, the moment of registration in the Registry gives rise to third-party effectiveness and determines priority.86 Here, Moldovan lawmakers used a different approach and also attributed (more specifically, left the previous rule unchanged) the constitutive effect to registration. In contrast, in Romania, for instance, Article 2.387 and 2.409 of the Civil Code provide that non-possessory pledge (called mortgage on movable assets) is created upon execution of the security agreement, nonetheless it only becomes effective when the secured obligation arises and the secured creditor acquires rights over the secured asset – in the case of perfect mortgage, by meeting the publicity requirements via registration in the Electronic Archive of Security Interests. Thus, registration in the Electronic Archive of Security Interests has a third- party effectiveness purpose, not a creation purpose.87 The possessory pledge, on the other hand, is constituted either by transmission of the asset to the creditor or by conservation of the asset by the creditor, with the consent of the debtor.88 The creditor’s possession of the pledged asset must be public and unequivocal. Nonetheless, registration in the Archive of Security Interests is not mandatory.89 To achieve third-party effectiveness and priority, alongside with the movable pledge, other security interests may be registered in the Charge Registry (e.g. financial leasing, unpaid seller’s charge, conditional assignment of claim). Nonetheless, the lack of registration thereof is not subject to invalidity.90 While special laws govern the registration of these security interests, the registration procedure is the general one established in P449.91 Additionally, P449 explicitly states that priority among security interests is established chronologically92 – even in the case of floating charges – according to the time of registration, and not according to the type of the security interest. Therefore, it is essential that interested third parties have access to the Charge Registry.

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However, given the lack of formalities of the pledge registration,93 hypotheses of illegal pledge registrations are not far from reality. Regarding unauthorized pledge registrations, A173 has not departed from the view expressed in the old P449. In the absence of any pledge-validity test upon registration, during the drafting phase of A173 legitimate concerns were raised about potential hoaxes from non-authorized parties registering a pledge right.94 To mitigate concerns, policy-makers adopted a moderate solution that promotes information reliability on two accounts.95 First, only authorized (and not licensed) operators could register the pledges.96 Second, the pledgor-signature requirement on the registration notice was preserved, adding the option of digital signature.97 Likewise, given the notification requirement upon enforcement of the pledge,98 and in order to prevent abusive contentions as to not having received the enforcement notice because of a change in domicile, it was set forth that notices sent to the pledgor’s address indicated in the Charge Registry would be deemed properly sent, the pledgor having the onus to record the change in address.99 Thus, this amendment intended to curtail pledgors acting in bad faith and bolster secured transactions reliability. Republic of Moldova Agroindbank v. Glorinal100 indicates that one enforcement notice conveyed to be pledgor at the time of defaulting on the loan agreement suffices although in the wake thereof changing events arise. Specifically, in this case the pledgee has served the pledgor (Glorinal) a notice of enforcement upon the pledgor’s default. This ensued negotiations between the pledgor and the pledgee as to the extension of the repayment of the loan, in exchange for Glorinal’s continuation of enjoying the possession of the pledged assets. The negotiations culminated in a debt reschedule agreement,101 which, indeed, lengthened the repayment timeframe by around one year. Glorinal had failed to repay the loan in the timeframe set out in the debt reschedule agreement. According to the Appellate Court decision, at the time of Glorinal’s default on the obligations under the debt reschedule agreement, the pledgee did not have the obligation to register a new enforcement notice.102 The Court’s decision is legally sound for a number of reasons. First, the purpose of the enforcement notification is to afford the debtor sufficient time to redeem its assets or to relinquish the possession of the secured assets. In cases where the secured creditor has expressed the intention of enforcing security rights against the debtor, even if there is a time lapse, the debtor can foresee a future course of actions. Second, the repayment obligation arising out of the loan agreement had not changed its source by having concluded the debt reschedule agreement; that is, concluding the latter does not extinguish obligations arising out of the former and does not give rise to new obligations. The debt reschedule agreement, as the name suggests, only alters the performance terms, mainly time related. Thus, even if the debtor had complied with the debt reschedule agreement, it would have executed obligations arising out of the loan agreement and not of the debt reschedule agreement.

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Finally, the encumbered assets are still the same, therefore the debtor knows by way of the enforcement notice which assets are to be enforced and what the reasons are for such enforcement. Noticeably, P449 does not regulate a second notice registration, regardless of the intervened circumstances (i.e. time lapse). Corollary, a hypothetical regulation of a second notice registration would bear the chance of steering up incentives to temporize the enforcement procedure. That is, dishonest pledgors could use such a requirement to seek annulment of an otherwise legal procedure. A number of provisions were set forth to avoid fraudulent and disloyal behaviour. First, in case of timely fulfilment of the pledgor’s obligations, the pledgee has a legal obligation deriving from the new Article 43 (3) of P449 to issue a pledge cancelation notice in order to delete the record of the pledge within 3 days after the pledge has been extinguished, subject to indemnification.103 Alternatively, if the parties have agreed so, the pledgee can submit the said notice directly to the Charge Registry. In addition, the pledgor can seek a court decision for cancelation of the pledge.104 Moreover, if the pledged assets were sold, the buyer, based on the sale confirmation issued by the pledgee, can seek cancelation of the pledge.105 Second, if the pledgor defaulted on its obligations, the pledgee may send a notice providing a reasonable time for performance.106 Lastly, any interested person can appeal against the Registrar’s refusal to register,107 change or cancel the pledge, unwarranted filing, late filing or refusal to provide the necessary information about the registration of the pledge.108 A particular matter which is still not regulated by P449 is the time limit for the pledge registration. While this could hypothetically be an issue, in practice, it does not raise concerns, as long as P449 maintains the old approach of registration as pledge constitutive effect and not only as third-party enforceability effect.

4. SUBSEQUENT PLEDGE

The subsequent pledge refers to situations where the debtor uses the same assets to secure obligations towards multiple subsequent creditors. Prior to A173, potential creditors could use their advantageous position in contract negotiations to include the subsequent pledge interdiction (in some jurisdictions known as “negative pledge”).109 Thus, if the pledgor had contracted against this clause, the security agreement would have been invalid between the parties of the agreement and against third parties. This rule did not distinguish between debtors’ credit worthiness and amount of pledged assets, which transformed it in a “creditors-prone” rule that did not favour neither creditors nor debtors. By 2014, the rule had translated into a “pledge-monopolization” practice, which had ostensibly given rise to inequity reverberations; remarkably, secured creditors who did not provide the requested additional financing refused to allow a subsequent pledge, thus blocking the further financing of the debtor.

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Amid the drafting phase of A173, unwilling to forgo the benefits of this rule, a chorus of financial institutions rallied for its preservation. In this case, both sides have good arguments: On the one hand, financial institutions wish to minimize credit risk by relying on a viable prospective pool of assets in case of enforcement. On the other hand, such are the demands of modern economy that require an active flow of secured credit to maintain a good standing on a vibrant market. Faced with a two-way pressure, our lawmakers decongested the gridlock by turning to acclaimed international standards that unequivocally argue in favour of the subsequent pledge and preventing unjustified prohibitions. Consequently, the amended provision states that the subsequent pledge shall be allowed unless other laws prohibit it for special reasons (hitherto, no such legal prohibitions exist). In the advent of what might seem at first absolute contractual liberty, several caveats are due. First, the pledgor shall inform each subsequent pledgee about all previous pledges, subject to the payment of indemnities. Second, subject to a similar sanction, the pledgor shall inform all previous pledgees about each subsequent pledge, immediately after the creation thereof. In the latter case, the pledgor will also have to communicate to prior pledgees the information regarding (i) the name of subsequent pledgee; (ii) the address of the pledgee; (iii) the description of the pledged asset; (iv) the essence and due date of the secured obligation, the maximum guaranteed amount thereof, excluding interest and expenses; (v) type of collateral.110 Finally, the altering of previous pledges will not be prejudicial to the rights of the pledgee holding a subsequent pledge, unless otherwise agreed by the subsequent pledgee and the pledgor.111 In case of augmentation of the secured obligation under the previous pledge, the pledge guaranteeing the amount of the accretion will have a lower priority as contrasted to the pledges created before the security of such an accretion was registered.112

5. ENFORCEMENT

Generally, enforcement is to the disadvantage of both the pledgee and the pledgor.113 For the pledgee, the enforcement procedure may result costly or cumbersome, while the pledgor faces the dispossession of the valuable assets that best fit its day-to-day business necessities. Given the underlying sensitive nature of this area, special attention needs to be paid to maximize efficiency and to conserve the resources of involved parties. Before the enactment of A173, the enforcement area was singled out as being “the most significant bottleneck area in the secured lending framework.”114 Major sources of concern stemmed from (i) the ineffectiveness of judicial proceedings in ordinance (as the pledgor could easily obtain the cancellation of the ordinance by filing objections thereto); (ii) once a judgment was granted, enforcement through the bailiff was ineffective and with

Central Bank Journal of Law and Finance, No. 1/2017 37 Republic of Moldova: First-Wave Reform of Security Interests Legal Framework delay; (iii) the possibility of delaying or even reversing the enforcement discouraged the purchase of pledged assets. With this in mind, lawmakers expanded the scope of self-help measures. On the one hand, secured creditors can obtain possession of secured assets if the pledgor expressly agreed to this in the security agreement or otherwise after the conclusion thereof.115 Therefore, after having duly notified the pledgor and the debtor of the secured obligation – if these are different persons –, any third party that holds the pledged asset as well as the other pledgees, the secured creditor can enter into the possession of the secured assets by concluding the “Act of transmitting possession of the tangible pledged asset.”116 On the other hand, if the debtor fails to transfer the possession voluntarily, A173 introduced the procedure of direct enforcement, without resorting to Court. Under this new proceeding, the creditor will go directly to the bailiff, who shall enforce the pledge given that the security agreement on movable assets has been attributed the character of an enforcement document.117 The new proceeding aimed to streamline the enforcement process significantly thus preventing financing backlogs and excessive provisioning by financial institutions. Debtors were also equipped with adequate protection tools, being able to resort to judicial control at any phase of the enforcement. Empirical evidence of enforcement of the new proceeding shows that it has served the purpose and indeed has become a major achievement of the legal reform.

6. OVERVIEW OF RECENT SECURED TRANSACTIONS REFORMS

A brief synopsis of foreign secured transactions systems would be helpful in order to illustrate the variety of approaches to the above concepts. While mindful of the fact that different market conditions and legal traditions propel different outcomes, we will list a few countries that have undergone a similar reformative process in the past years.

6.1. United Arab Emirates (UAE) On 15 March 2017 the new Law on the Pledge of Movables as Security for a Debt No 20. of 2016 entered into force.118 A remarkable innovation of the new law is the creation of an electronic Registry that will contain information on pledges.119 It is still unknown what information the Registry will foster, but it is certain it will ensure the publicity of all created pledges.120 The advent of the Registry follows the regulation of a non-possessory pledge, after a history of possessory guarantees.121 Likewise, it seems that the new law has also broadened the scope of the object of the pledge which incorporates, inter alia, bank accounts (deposits), receivables, bonds and

38 Central Bank Journal of Law and Finance, No. 1/2017 Roger Gladei, Patricia Handraman similar financial instruments, equipment among other tangible commercial assets, goods on consignment, raw material and agricultural products. Enforcement and priority dispositions lay out that (i) the first-come-first-served tenet grants priority to preceding secured creditors; (ii) a registered security interest automatically extends to proceeds of disposition of a pledged asset, which, in turn, follows the priority regime of the former; (iii) depending on the practicalities of specific encumbered assets, a number of self-help remedies are available to the secured creditor, including seizure and sale of the secured asset.122 UAE lawyers praise the new law as being a “[s]tep in the right direction” and a “[m]ove toward greater transparency in commercial life in the Emirates.”123

6.2. Italy The entry into force of the new Italian pledge law (known as Banks’ Decree) on 29 June 2016 attempted to align the Italian system to the international standards set out by the United Nations Commission on International Trade Law (UNCITRAL) and by the World Bank.124 Regardless, easily discernible contrasts between the new law and the UNCITRAL relate to (i) the publicity requirement to register the security agreement rather than a notice of registration of the pledge, (ii) conditioning the creation of a security right to registration in the electronic Registry, (iii) unwarrantedly maintaining several Registries.125 Likewise, although UNCITRAL recommends a unitary comprehensive reform of pledge related laws, the Italian lawmakers have not altered a number of instrumental regulations in connection to the pledge.126 The Banks’ Decree introduces the non-possessory pledge that can encumber a wide array of assets. The legal confusion may create the confinement of the new law’s scope to certain present, future, tangible and intangible assets, and to the exclusion of assets subject to special registration, such as motor vehicles, patents, trademarks and registered design.127 Consequently, the excluded category will be subject to registration in a different Registry.128 A new electronic Registry will be held by the Tax and Revenue Agency. For registration purposes, a succinct description of the pledged assets shall suffice.129 Similar to other legal systems, priority is determined by the moment of registration of the secured interest.130 The parties may negotiate a clause that entitles the secured creditor to dispose of the secured assets (e.g. lease), or which would operate a possession transfer in case of debtor’s default.131 Altogether, the new law, despite indeed having increased access to credit by adopting the non-possessory pledge, is commonly perceived as having failed to provide a fully-fledged legal framework. Moreover, critics consider the new law has sown complexity rather than diffusing it.

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6.3. The Russian Federation 1 January 2017 was marked by the entry into force of the Law on Movable Pledge for Commercial Transactions No. 6750.132 Although broadly extending the scope of the pledge, the new law has introduced an interdiction to pledge a body of assets if single identifiable assets provide sufficient security to creditors.133 Enforcement remedies are still largely in need for an authority – either a bailiff or a Court.134 In bankruptcy, in order to obtain ownership of the secured assets, a bailiff will rank secured creditors according to priority, indicating the amounts due to each of them.135 Secured creditors have a limited seven-day time period to object to the list, subject to an invalidity sanction.136 Self-help measures relate to (i) transferring the secured assets into the secured creditor’s possession; (ii) transferring the secured assets to an asset managing company; (iii) licensing or leasing rights deriving from intangible secured assets.137 Despite the novelties of the new law, lawyers consider it yet to be exuding any clear conclusions as to its application.138

7. CONCLUSION

Despite the fact that several amendments were made over time, by early 2000s, P449, enacted back in 2001, has required significant interventions, in order to align with the economic realities and to the best international standards. Relevant EU legislation on the matter is absent; therefore the UNCITRAL Model Law on Secured Transactions has become a worthy source of reason and solutions for Moldovan policymakers, who could also rely on the recent successful stories of other reformer country (e.g. Romania, the Russian Federation, and Croatia). The fair public consultation process, the transparent dialogue with all stakeholders and a thorough ex-ante regulatory impact analysis were the factors that contributed to designing a set of rules which took into account the sometimes opposing interests of stakeholders, particularly the financing institutions, on the one hand, and businesses and consumers, on the other hand. A systemic assessment of the new legal regime outcome is probably too early at this time, however, empirical data show that the novelties and improvements brought by the amendment law enacted back in November 2014 have been well-received by the market players and tend to strike the balance of interests which is the prerequisite for improving access to finance and ensuring economic growth.

40 Central Bank Journal of Law and Finance, No. 1/2017 Roger Gladei, Patricia Handraman

NOTES

1The World Bank – Europe and Central Asia Region (Financial and Private Sector Development Department), Improving Access to Credit through Secured Transactions Reform: Republic of Moldova [hereinafter Report] (2010). 2 Id. at 2, 8. 3 Id. at 10. 4 Id. at 7. 5 The exchange rate of EUR to MDL (Leu) is ca. 1/21. 6 See Report supra note 1, at 12; see also NATIONAL BANK OF REPUBLIC OF MOLDOVA, Situaţia financiară a sectorului bancar în 2014 [Financial Situation of the Banking Sector in 2014] (2014). Noticeably, the share of foreign investments in the banks’ capital constituted 78.6 per cent in 2010, 76.4 per cent in 2014, and 82.7 per cent in 2015. See also NATIONAL BANK OF REPUBLIC OF MOLDOVA, Situaţia financiară a sectorului bancar [Financial Situation of the Banking Sector] (2010-15). 7 See NATIONAL BANK OF REPUBLIC OF MOLDOVA, Situaţia financiară a sectorului bancar în anul 2013 [Financial Situation of the Banking Sector in 2013] (2013). 8 See NATIONAL BANK OF REPUBLIC OF MOLDOVA, Situaţia financiară a sectorului bancar în semestrul I 2017 [Financial Situation of the Banking Sector in the First Semester of 2017] (2017). 9 Roger Gladei, Presentation at Financial Sector Lawyers: Movable Pledge and Leasing in the Light of the Recent Legislative Amendments (Nov. 19, 2014). 10 Id. 11 See ROSS CRANSTON, THE PRINCIPLES OF BANKING LAW 433 (1997). 12 Id. at 433. 13 See Cranston, supra note 11, at 435. 14 Id. 15 See infra p. 15. 16 See Civil Code, Article 457 (2002); see also Pledge Law, Article 8 (2001). 17 See MIHAI POALELUNGI ET AL., MANUALUL JUDECĂTORULUI PENTRU CAUZE CIVILE [JUDGE'S HANDBOOK FOR CIVIL CASES] 882 (2013). 18 JEAN-PHILIPPE LÉVY & ANDRÉ CASTALDO, HISTOIRE DU DROIT CIVIL [HISTORY OF CIVIL LAW] 1063-64 (2002). 19 Id. 20 Id. 21 Id. 22 United Nations Commission on International Trade Law [hereinafter UNCITRAL], Legislative Guide on Secured Transactions, U.N. Publ’n, N.Y., para. 52, 43 (2010); see also E.P. ELLINGER ET AL., MODERN BANKING LAW 724 (2002).

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23 Where intangible assets are encumbered, the creditor may retain the documents that give rise to such rights. UNCITRAL, supra note 22, para. 54, 44. 24 See Ellinger, supra note 22, at 756; see also Cranston, supra note 11, at 436. 25 Shortly, any enforcement procedure commences with the pledgees conveying a notice of execution to the pledgor allowing the latter at least ten days for voluntary execution (subject to registration in the Charge Registry). It seems, according to recent jurisprudence, that granting time for voluntary execution should be balanced in the light of the size of the debt; that is, more time should be granted where the payable debt is greater. Nonetheless, Courts have failed to suggest an algorithm to determine a precise time that should be given to the pledgor to redeem the pledged assets; they rather seem to scrutinize the issue on a case-by-case basis. After having received the notice of execution, the debtor can either (i) redeem the pledged assets by executing the obligations, or (ii) transfer the pledged assets to the pledgee. In the former scenario, the parties of a security agreement often agree to a new payment schedule. Finally, if none of these measures yielded results, the secured creditor could obtain possession of the pledged assets either one-sidedly (if such a clause existed in the pledge agreement) or by way of a court order (contentious procedure) or ordinance (non-contentious procedure). For a similar enforcement summary preceding A173, see Report supra note 1, at 18. 26 See Poalelungi, supra note 17, at 873; see also COMENTARIUL CODULUI CIVIL AL REPUBLICII REPUBLIC OF MOLDOVA [COMMENTARY OF THE CIVIL CODE OF THE REPUBLIC OF MOLDOVA] 723 (2005). 27 See Poalelungi, supra note 17, at 873. 28 See Mortgage Law (2008). 29 Gladei, supra note 9. 30 See generally UNCITRAL, supra note 22, para. 57, 21-2. 31 See infra, p. 5. 32 Gladei, supra note 9. 33 Gladei, supra note 9. 34 See Lévy, supra note 18, at 1066 (pointing to how pledge laws have changed in the French history, from the old practice where debtors pawned goods with personal value to the impressive array of goods that can be pledged nowadays). 35 See Decision on the Application of Some Provisions of Pledge and Mortgage Legislation of the Plenary of the Supreme Court of Justice, para. 7, 3 (2014) [hereinafter Pledge Decision]. 36 Gladei, supra note 9. 37 For a discussion on the possibility of using money as collateral see generally BAIEȘ SERGIU ET AL., DREPT CIVIL: TEORIA GENERALĂ A OBLIGAȚIILOR [CIVIL LAW: GENERAL THEORY OF OBLIGATIONS] 643 (2015); Gladei, supra note 9. 38 For a different terminology, see UNCITRAL, supra note 22, at 7, 27, 107 (referring to this kind of security as “a security right in a right to payment of funds credited to a bank

42 Central Bank Journal of Law and Finance, No. 1/2017 Roger Gladei, Patricia Handraman

account”); see also Ellinger supra note 22, at 802 (employing the term of “charges over bank balances”). 39 The dichotomous approach to money – economic and juridical – is not novel; as Garrigues shrewdly asserted “[i]t is only money that which the law or custom has recognized as being money,” see JOSÉ LUIS LACRUZ BERDEJO ET AL., DERECHO DE OBLIGACIONES [OBLIGATIONS LAW] 88 (2011). In the Moldovan jurisdiction, money enjoys the juridical regime of goods by virtue of Article 302 corroborated with Article 284 of the Civil Code. 40 Gladei, supra note 9. 41 Banks are required to keep confidential all the facts that they learn in business relationships with customers. Nonetheless, this obligation is quenched if the information concerns general information that does not prejudice the interests of the client if disclosed. 42 See Cranston, supra note 11, at 432; see also Ellinger, supra note 22, at 724 (outlining the importance of collateralization in case of debtors’ insolvency). 43 See UNCITRAL, supra note 22, at 137-40. 44 Notably, another way of achieving third-party effectiveness of a pledge on a bank account is by registering the pledge in the Registry. See Pledge Law, Article 251 para. (1) (2001). 45 See Civil Code, Article 1239 (2002). 46 Id. at 1222. 47 UNCITRAL, supra note 22, at para 143, 139. 48 See Pledge Law, Article 57 (6) (2001). 49 See UNCITRAL, supra note 22, at para. 146, 139. 50 Gladei, supra note 9. 51 See Ellinger, supra note 22, at 654 (noting that a financial institution will not grant a loan if it has doubts as to the client’s bona fides); accord Report, supra note 1 at 18 (pointing that due to the unreliability of borrowers’ financial books, financial institutions weight previous relations between the financial institution and the borrower, and the availability of strong third-party guarantees to assess creditworthiness). 52 See Pledge Law (2001), Article 9 para. (3)-(4). 53 Id. at Article 251 para. (3). 54 Id. at para. (7). 55 Id. at para. (8). 56 Id. at para. (4). See also Civil Code, Article 1232, 651 (2002). 57 Id. 58 UNCITRAL, supra note 22, at para. 146, 139; see also Ellinger, supra note 22, at 802 (arguing that the restrictive scope of application of the set-off right has propelled

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numerous English banks to incorporate a set-off clause in the financial agreement between them and their borrowers). 59 See Pledge Law, Article 251 (3) (2001); see also Ellinger, supra note 22 at 803 (noting the priority of a bank’s set off right over other creditors’ rights on the funds). 60 UNCITRAL, supra note 22, at para. 146, 139. 61 UNCITRAL, supra note 22, at para. 144, 139. 62 The declaration is void if it is affected by modalities. See Civil Code, Article 651 para. (4) (2002). 63 Pledge Law, Article 661 para. (1) (a) (2001). 64 See Pledge Law, Article 661 (2001). 65 See generally FRANÇOIS TERRÉ & PHILIPPE SIMLER, DROIT CIVIL: LES BIENS [CIVIL RIGHTS: GOODS] 38 (1998). 66 Id. 67 Id. 68 Id. 69 Id. 70 Pledge Law, Art. 25 (2001). 71 Id. 72 Banca de Finante și Comert SA vs Victoriabank SA, No. 02-2ac-8093-13042016, Dec. 19, 2016 (Chisinau Appelate Court dec., No. 9, 2016). 73 See UNCITRAL, supra note 22, at para. 23, 36. 74 See UNCITRAL supra note 22, at para. 22, 36. 75 See Pledge Decision, supra note 35, at para. 37, 14 (2014). 76 See also Ellinger, supra note 22, at 760. 77 See UNCITRAL, supra note 22 at para. 125, 218. 78 Id. 79 See Pledge Law, Article 37 para. (1) (2001). 80 See Pledge Law (initial version), Article 7 (2001). 81 See Pledge Law, Article 37 para. (1) (2001). 82 Gladei, supra note 9. 83 See Pledge Law (initial version), Article 47 (2001). 84 See UNCITRAL, supra note 22, at para. 66, 25. 85 Gladei, supra note 9. 86 Id. 87 Comparatively, in England it is not clear whether a pledge is validly created upon the execution of a security agreement or upon pledge registration in the Companies Register. On the one hand, Section 395 (1) of the Companies Act of 1985 provides a twenty-one- day-registration rule in which the parties of a pledge agreement shall register the pledge, subject to an “invalidity sanction,” which renders the pledgee’s rights under the pledge

44 Central Bank Journal of Law and Finance, No. 1/2017 Roger Gladei, Patricia Handraman

agreement ineffective. This sanction does not affect the pledgee’s rights of enforcement against the pledgor, nonetheless, the creditor will become unsecured as against other secured creditors. On the other hand, regulations of particular pledge objects, such as intellectual property, aircraft and ships provide that registration is mandatory for third- party effectiveness. This uncertainty seems to create difficulties for secured creditors. Notably, where the pledge has not been registered in the time limit provided by law, obligations rising out of the security agreement become immediately enforceable against the pledgor. See Ellinger, supra note 22, at 760. In what concerns similar security agreements concluded with consumers, the same deficiency causes the security to be enforceable only by a court order, while in other cases the security agreement will be considered as “[n]ever having effect”; see Cranston, supra note 11, at 454. 88 Romanian Civil Code, Article 2481 (1) (2011). 89 Id. at 2482. 90 Gladei, supra note 9. 91 Id. 92 But cf. Ellinger, supra note 22, at 763. The authors argue that, in English law, a number of circumstances may disturb the chronological factor. First, due to the nature of floating charges, subsequent fixed charges shall entitle a secured creditor preference over the assets. Ellinger explains that “[t]he essence of a floating charge is that the chargee permits the company to carry on dealing with (including charging) its assets. Thus, a subsequent fixed charge generally takes priority over a prior (uncrystallized) floating charge.” Second, a charge which shall be registered under the English law but which is not registered loses priority against a subsequent secured creditor even if the latter knew about the former’s charge. However, the law is uncertain as to the situations where both the former and the latter chargees have not registered their security rights. Finally, theoretically – that is, as deemed by the authors, not likely to occur in practice due to the access to the Charge Registry availability to third parties –, a bona fides purchaser of the secured asset is to have priority over equitable chargees. 93 Mostly, due to the Registrar’s lack of competency to request the pledge agreement or verify the data contained in the registration notice; see Pledge Law, Article 39 (4) (2001). 94 Gladei, supra note 9. 95 Id. 96 Id. 97 See Pledge Law, Article 39 (3) (2001). 98 The rule provides that any secured creditor shall notify the debtor and allow a time period of at least 10 days for execution of the debt or for conveyance of the secured assets; see Pledge Law, Article 67 (1) (2001). 99 See Pledge Law, Article 39 (8) (2001). 100 B.C. “Republic of Moldova Agroindbank” S.A. v. S.R.L. ”Glorinal,” No. 02-2ac-21331- 18092016, Aug. 15, 2017 (Chisinau Appelate Court dec., Apr. 25, 2017).

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101 Some sources use the “debt-readjustment agreement” term to refer to this type of agreements. See UNCITRAL, supra note 22, at para. 4, 276. 102 Thus, the Court dismissed Glorinal’s argument according to which the pledgee had an obligation to register a new enforcement notice since the underlying legal basis for the enforcement changed due to the new legal regime governing the relations between the parties set forth in the debt reschedule agreement. 103 The practice of allowing only the creditor to extinguish a security right by way of cancelation notice hinges on security reasons. See UNCITRAL, supra note 22, at para. 107, 176. 104 See Pledge Law, Article 43 (2001). 105 Id. 106 See Indian Contract Act 1872 for a similar condition precedent for sale of the pledged goods. 107 There are only two hypotheses where the Registrar can deny notice registration: (i) the notice does not embody the data provided in Article 56 of the Regulation on Charge Registry, or (ii) registration taxes were not paid (around 20 EUR). 108 See Pledge Law, Article 44 (5) (2001). 109 See Ellinger, supra note 22, at 789. 110 Id. 111 Id. 112 Id. 113 See UNCITRAL, supra note 22, at para. 4, 275. 114 See Report, supra note 1, at 4. 115 See Pledge Law, Article 70 (2001). 116 Id. 117 See Enforcement Code, Article 11 n). 118 See DOUGLAS G. SMITH, New UAE Pledge Law Takes Effect (2017). 119 Id. 120 Id. 121 Id. 122 Id. 123 Id. 124 GIULIANO G. CASTELLANO, The New Italian Law for Non-possessory Pledge: Villain or Hero? (2016) Oxford Business Law Blog. 125 Id. 126 Id. 127 Id. 128 Id. 129 Id.

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130 Id. 131 Id. 132 GÜR Law Firm, New Law on Movable Pledge for Commercial Transactions and its Application (2017). 133 Id. 134 Id. 135 Id. 136 Id. 137 Id. 138 Id.

Central Bank Journal of Law and Finance, No. 1/2017 47 Republic of Moldova: First-Wave Reform of Security Interests Legal Framework

REFERENCES

1. Baieș, Sergiu et al., “Drept civil: Teoria generală a obligațiilor” [“Civil Law: General Theory of Obligations”], 643. 2. Cranston, Ross, “The Principles of Banking Law”, Oxford University Press, New York, 1997, 432-33, 435-36, 454. 3. Ellinger, E.P.; Lomnicka, Eva; Hooley, Richard, “Modern Banking Law”, Oxford University Press, New York, 2002, 724, 760, 763, 802. 4. Lacruz Berdejo, José Luis et al., “Derecho de Obligaciones” [“Obligations Law”], Dykinson, Madrid, 2011, 88. 5. Lévy, Jean-Philippe; Castaldo, André, “Histoire du droit civil” [“History of Civil Law”], 2002, 1063-64. 6. Poalelungi, Mihai et al., “Manualul judecătorului pentru cauze civile” [“Judge's Handbook for Civil Cases”], 2013, 873, 882. 7. Terré, François; Simler, Philippe, “Droit civil: Les biens” [“Civil Rights: Goods”] (1998), 38.

48 Central Bank Journal of Law and Finance, No. 1/2017 The External Competitiveness of the Romanian Economy

Ana-Maria Cazacu*

Abstract

We analyse the external competitiveness of Romania on three main levels: macroeconomic, firm-level and through the position within the global value chains. The results indicate that Romania has improved its competitive capacities in the last years, but certain structural vulnerabilities related to the asymmetry of performances, financial indiscipline and low innovation level among non-financial companies persist. The issues diminish the medium and long term potential of increasing competitiveness and represent the reason for domestic firms’ positions at lower stages in the global production chains. We highlight that improving firms’ financial discipline and their competitiveness indicators (especially microeconomic productivity) would have positive effects on the export capacity, external balance, but also on the banking sector, government budget and, naturally, on the economic growth potential. In this respect, we formulate a series of potential measures for obtaining sustainable competitive gains (by improving the general economic environment and legislative framework, increasing the efficiency level in the economy and firms’ orientation towards a business model based on technology and knowledge).

Keywords: competitiveness, foreign trade, microeconomic analysis, financial discipline, heterogeneity, multifactorial productivity, real convergence, global value chains

JEL Classification: C23, D22, D24, F10, F23, F60

* PhD, Adviser to the First Deputy Governor This work consists of selected results from Ana-Maria (Bancu) Cazacu’s PhD thesis, Bucharest University of Economic Studies, 2017; supervisor: Florin Georgescu, PhD, Professor at Bucharest University of Economic Studies, NBR First Deputy Governor. The opinions expressed in this paper are those of the author and do not necessarily reflect the views of the National Bank of Romania, nor do they engage it in any way.

Central Bank Journal of Law and Finance, No. 1/2017 49 The External Competitiveness of the Romanian Economy

LIST OF ABBREVIATIONS

ECB European Central Bank EU European Union Eurostat Statistical Office of the European Union GCI Global Competitiveness Index GDP Gross Domestic Product GVA Gross Value Added GVC Global Value Chain IDE-JETRO Institute of Developing Economies-Japan External Trade Organization IMF International Monetary Fund MPF Ministry of Public Finance NBR National Bank of Romania NIS National Institute of Statistics NTRO National Trade Register Office OECD Organisation for Economic Co-operation and Development P&L Profit and Loss PVAR Panel Vector Auto-regression R&D Research and Development REER Real Effective Exchange Rate ROE Return on Equity SME Small and Medium Enterprises ULC Unit Labour Cost VAR Vector Auto-regression WIOD World Input-Output Database WTO World Trade Organization

50 Central Bank Journal of Law and Finance, No. 1/2017 Ana-Maria Cazacu0F

1. INTRODUCTION

In recent years, both academics and policy makers have increasingly focused on understanding the role of external competitiveness. Despite the rich literature focusing on this topic (Porter, 1990; Krugman, 1994; Hummels et al., 2001; Hausmann et al. 2007; Ilzkovitz et al., 2008; Di Mauro and Forster, 2010; Koopman et al., 2012; Benkovskis and Wörz, 2013 etc.), competitiveness remains a multidimensional concept, capturing aspects related to macroeconomic indicators (both price and non-price factors related to institutions, infrastructure, political, social and legal framework etc.), firm-level performances and cross-border aspects, on the grounds of emerging global value chains. As such, the ability of being competitive influences the welfare of a nation and the proper functioning of an economy directly and indirectly, Ezeala-Harrison (1999) arguing that international trade is the engine of economic growth, while international competitiveness is the fuel that empowers the engine. Nkusu (2013) also finds a direct link between macro- level competitiveness, exports, economic growth and fiscal performance. Nevertheless, the macro approach of competitiveness, based on a representative agent, proved to be less satisfactory, given the high firm-level heterogeneity (Bernard et al. 2011). In order to properly assess a region’s competitive position, it is necessary to complement traditional aggregate macro indicators with microeconomic foundations. As such, the centre of the international trade studies started shifting from countries and industries towards firms and products. Models introduced by Bernard and Jensen (1995) or Melitz (2003) focus on firm heterogeneity, resource reallocation and differences between trading and non-trading firms. All these aspects have significant implications for external trade and aggregate productivity growth. The Competitiveness Research Network (2014) shows that micro-level data contribute to a better understanding of external competitiveness, as firm heterogeneity hides different behaviours related to productivity and unit labour costs. Assessing the main drivers of international sales and the impact of the increased international trade on micro-level performance is of vital importance for a small and open economy, such as Romania. Thus, the goal of this study is to identify the main determinants and to assess the competitive position of Romanian firms, by means of three approaches: macroeconomic, microeconomic and the analysis of domestic companies’ positioning into the global value chains. The mentioned approaches are the pillars based on which we offer a holistic framework for assessing the external competitiveness of the Romanian economy, explaining the macroeconomic developments and the regional role of domestic companies throughout a disaggregate analysis of firm-level indicators. The paper is organised as follows: in the first chapter, we present the latest developments related to Romania’s external performance (in terms of exports, REER, overall economic efficiency etc.) and we argue that non-price competitiveness is the most important factor for achieving a sustainable economic growth in a PVAR methodology; in the second

Central Bank Journal of Law and Finance, No. 1/2017 51 The External Competitiveness of the Romanian Economy chapter, we perform an in-depth analysis of firms’ financial health, based on balance sheets and P&L statements, as individual performances represent the pillar for aggregate results; in the third section, we use Koopman et al. (2012) methodology for assessing Romania’s degree of integration in the global value chains. In the end, we formulate potential policy options that can be taken into account for enhancing the competitiveness, productivity and attractiveness of the Romanian economy. The main databases vary from those at country/region/sector level (Eurostat, NIS, WIOD, World Bank, IMF) to detailed firm-level information, based on financial data (balance sheet, profit and loss account, external trade activity, insolvency) for all Romanian companies (provided by MPF, NIS, NTRO) and information about firms from other EU countries (Orbis Bureau van Dijk).

2. MACROECONOMIC COMPETITIVENESS OF ROMANIA

In this section, Romania’s competitive position is analysed, based on a large variety of macroeconomic indicators, capturing both price indicators and non-price factors. OECD (1992) defines macro-level competitiveness as "the capacity of a country to make products that stands the test of international competition, simultaneously with an increase in national real income”. Until recently, the most commonly used indicators in assessing competitiveness were price related: external balance, export market shares, ULC, REER, labour productivity etc. Nevertheless, Ilzkovitz et al. (2008) underline the necessity of taking into account the non-price factors of competitiveness, such as: geographical specialization of exports, technological opportunities, production capacity (structural competitiveness) etc.

0.35 4.00

0.30 3.50

3.00 0.25 2.50 0.20 2.00 0.15 1.50 0.10 1.00

0.05 0.50

0.00 - 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 share in world's exports share in EU28 exports (rhs)

Figure 1: Romania’s Market Share (percent) Source: Eurostat

52 Central Bank Journal of Law and Finance, No. 1/2017 Ana-Maria Cazacu0F

Macroeconomic analysis shows that Romania has certain cost and price competitive advantages. The share of Romanian goods exports has followed an upward trend in the past years, except for 2012 (Figure 1). As of 2014, Romania’s exports have accounted for: (i) 0.33 percent of world exports (compared to 0.31 percent in 2013 and 0.28 percent in 2012) and (ii) 3.43 percent in the EU28 (from 3.34 in the previous year). The increased market share in international markets was, most probably, due to the low unit labour cost, which in Romania is the second lowest in the EU (5 euro/hour, compared to the European average of 25 euro/hour). Nevertheless, the registered situation shows that Romania still lags behind the European average in terms of labour productivity per worker (half of the EU average, Figure 2), despite the relatively high growth rate of labour productivity in the last years.

Figure 2: Labour Productivity Source: Eurostat

Moreover, an increase in export market share was recorded even though the local currency appreciated, especially during the boom period. As well as other Central and Eastern European countries, despite recording episodes of real appreciation of the currency (which would suggest price competitiveness losses), these countries actually increased their market shares (Figure 3).

Central Bank Journal of Law and Finance, No. 1/2017 53 The External Competitiveness of the Romanian Economy

These divergent evolutions highlight the importance of a wide variety of factors that influence countries’ external performance and the need for adjusting the traditional competitiveness indicators with non-price indicators reflecting product quality, taste and consumer preference etc.

Figure 3: REER and Export Market Share yoy Change Source: Eurostat Note: a positive value of REER change indicates a currency appreciation Thus, turning to a more qualitative approach of competitiveness, we find that certain non- price competitiveness aspects hinder Romania’s competitiveness potential and can affect the medium and long term exporting capacity. These are mainly related to infrastructure, the quality of public institutions and business environment, as well as to deficiencies in health and education systems. The Global Competitiveness Index, developed by the World Economic Forum, places Romania on the 59th place out of 144 in 2014-2015, the main drawbacks being the innovation and sophistication factors, as well as the basic requirements, such as institutions and infrastructure (Figure 4). This is a serious reason for concern, since the public sector can have a valuable contribution to the external competitiveness of an economy if it is centred on the structural foundations of the economy. A well-developed infrastructure, together with a well trained staff in public institutions can contribute to the ease of doing business.

54 Central Bank Journal of Law and Finance, No. 1/2017 Ana-Maria Cazacu0F

Moreover, some regions such as South East Dobrogea, South Muntenia and South West Oltenia display an important gap in terms of competitiveness compared to other European areas, especially due to their low technological capacities.

Institutions 100 Innovation Infrastructure 80 Business 60 Macroeconomic sophistication environment 40 20 Health and primary Market size 0 education

Technological Higher education readiness and training

Financial market Goods market development efficiency Labour market efficiency

Figure 4: Romania’s Ranking According to the Global Competitiveness Index (2014-2015) Source: World Economic Forum Note: a positive value of REER change indicates a currency appreciation Maintaining price competitiveness is important, but, for a sustainable export growth, solving the structural problems of the national economy, reflected by non-price factors, is essential. This is because non-price factors have a higher potential for assuring superior economic growth in the longer term, as we have shown for the case of EU member states in the recent period. We used annual data for testing the link and direction of causality between economic growth (measured by GDP or GDP per capita) and competitiveness (measured by GCI and its pillars, REER and exports value) for 28 European Union countries during 2006-2013. The methodology for assessing the causal relationship between economic growth and competitiveness variables is a panel-data VAR (PVAR). The estimations were performed in Stata. According to Canova and Ciccarelli (2013), a PVAR model can be formalized as:

= ( ) + ( ) +

𝑌𝑌𝑡𝑡 𝐴𝐴0 𝑡𝑡 𝐴𝐴 𝑙𝑙 𝑌𝑌𝑡𝑡−1 𝑢𝑢𝑡𝑡

Central Bank Journal of Law and Finance, No. 1/2017 55 The External Competitiveness of the Romanian Economy where:

is a ( 1) vector of endogenous variables for each unit ( = 1: ), i.e. = ( , … ) , ′ ′ ′ ′ 𝑌𝑌𝑡𝑡= 1: 𝐺𝐺𝐺𝐺, ( ) is a lag polynomial and 𝑖𝑖 𝑖𝑖 𝑁𝑁 𝑌𝑌𝑡𝑡 𝑦𝑦1𝑡𝑡 𝑦𝑦2𝑡𝑡 𝑦𝑦𝑁𝑁𝑁𝑁

𝑡𝑡 = =𝑇𝑇 (𝐴𝐴 𝑙𝑙 , … ) is iid vector of errors. ′ ′ ′ ′ 𝑢𝑢Prior𝑡𝑡 𝑌𝑌𝑡𝑡 to the𝑢𝑢1𝑡𝑡 estimations,𝑢𝑢2𝑡𝑡 𝑢𝑢𝑁𝑁𝑁𝑁 the data are Helmert transformed (Helmert observation at t moment is the original variable at t moment, out of which the average of observations from t+1 to T average of all future observations is deducted). The time series are stationary, as indicated by panel unit root tests. Based on information criteria and in order to have a larger number of degrees of freedom, we estimate a one lag PVAR model.

Impulse response functions (Figure 5), as well as variance decomposition and Granger causality, highlight that non-price competitiveness (captured by the global competitiveness index) has a greater influence not only on GDP evolution, but also on the external performance (expressed by exports’ volumes and REER).

Results of different PVAR specifications indicate that the impact of gains in the overall competitiveness of the economy (GCI) is more important for the improvement of economic development than simple increases in exports’ volume or exports market shares. At the same time, advances in competitiveness, for example in the quality of nations’ institutions, lead to real currency appreciation in both short and long term. These relations also hold when using GDP per capita instead of GDP levels. Some of the most important pillars of non-price competitiveness, according to their impact on economic growth, are those related to institutions and infrastructure.

In the longer term, the accumulated responses of GDP levels to positive shocks in global competitiveness are higher than in the case of increases in exports market shares of export sales volume. At the same, a positive shock in global competitiveness has a positive effect, in the long term, on export performance. On the other hand, intensification in exports activity does not seem to have a significant impact on the overall competitive position of the economy, suggesting that, for sustained gains in competitiveness, an economy has to record improvements in many indicators, most probably, related to non-price factors, not only in international sales. This conclusion is also supported by the insignificant effect of REER appreciation (the confidence interval includes level 0) on global competitiveness.

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Figure 5: Short Term Impulse Response Functions Source: IMF, World Bank, World Economic Forum, author’s own computations Note: gdp_bm=GDP;GCI=global competitiveness indicator; exp_g= goods exports. Values are expressed in log-levels and Helmert transformed.

After 5 years from the shock production, the global competitiveness indicator explains over 10 percent of GDP variation, compared to below 1 percent of output variation explained by exports’ market share. Also, global competitiveness explains approximately 7 percent of GDP per capita evolution, compared to 1 percent due to REER evolution. GDP per capita evolution also seems to be explained to a higher extent by non-price factors captured by the pillars related to institutions and infrastructure (as computed by the World Economic Forum), compared to REER.

3. MICROECONOMIC FUNDAMENTALS OF ROMANIA’S COMPETITIVENESS

The macroeconomic aspects of competitiveness are definitely a valuable contribution to the assessment of the competitive position of a country, region or industry, but for a deeper understanding of the aggregate phenomena, we need further insights on firm-level developments. Microeconomic analysis highlights the reasons why Romania is on the second lowest position in the EU in terms of productivity, which translates into medium

Central Bank Journal of Law and Finance, No. 1/2017 57 The External Competitiveness of the Romanian Economy term difficulties of sustaining the competitiveness of the internal business environment and external sales. Efficiency micro-level indicators exhibit a high degree of asymmetry, which has stood still in the last years. There exist a small number of highly productive firms and numerous companies with low productivity level. This heterogeneity also justifies the regional disparities and the modest role in export activities of certain regions/counties (Figure 6).

North East Moldova Bucharest - Ilfov 5% 15%

South East Dobrogea 11%

Centre 16% South Muntenia 18%

North West 12%

South West Oltenia 6% West 17%

Figure 6: Exports’ Structure by Region (2014) Source: NIS, NTRO, author’s own computations

The least competitive regions in Romania (South East Dobrogea, Centre and South West Oltenia) are also characterized by low productivity and technological capacities (Figure 7). The domestic business model is not based on innovation, as the activity in technology intensive sector in most regions is concentrated in FDI firms. This is worrisome, since Romania also has a reduced share of GDP allocated for innovation expenses. Productivity asymmetry and modest involvement of domestic firms in sophisticated businesses also substantiate Romania’s vulnerabilities signalled by macroeconomic non-price indicators.

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thousands RON/employee 120

100

80

60

40

20

- South South East North East South West North Centre Bucharest West Dobrogea Moldova Muntenia West - Ilfov Oltenia

Figure 7: Labour Productivity Distribution by Region (2014) Source: NBR, MPF, NTRO, author’s own computations Note: The bar denotes the interquartilic range (p25-p75), the dot the mean and the line the median of the distribution.

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1% 5% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Figure 8: Exports’ Cumulative Distribution (2014) Source: MPF, NIS, author’s own computations Note: Ox represents cumulative distribution of total number of exporters, while Oy denotes cumulative exports’ value.

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Against this backdrop, export activities record a high degree of concentration, the top 10 percent companies ordered by export value cumulating 88 percent of the total (Figure 8), while 78 percent is accounted by foreign owned companies. Geographical and assortment diversification of external trade is modest, with more than half of the exporters having a single destination market, while 70 percent export less than 5 product varieties. Taking into account the recent empirical evidence in the field, a higher diversification could contribute to an increased innovation and to growth opportunities (Hesse, 2008; Amurgo-Pacheco and Pierola, 2008). Firm level analysis by different categories highlights that there are systematic differences among micro performances not only across regions/sectors/size classes, but also within the same category. The market is formed of a low number of very performant firms and a large number of companies with no activity or modest performances (characterized by high indebtedness, reduced liquidity, productivity and profitability). Out of over 600,000 existing firms, around 26 percent (158,000) are inactive, namely these reported a null turnover in 2014 (Figure 11). In the case of active firms, more than 40 percent (178,000 companies) record net losses (Figure 9). Those losses have reached worrying levels in the last years, ranging from 36 to 42 billion lei from 2009 onwards (Figure 10).

thousands units 250

200

150

100

50

- 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Figure 9: Number of Loss Making Companies Source: MPF, NTRO, author’s own computations

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bln. RON 0

-5

-10

-15

-20

-25

-30

-35

-40

-45 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Figure 10: Evolution of Aggregate Loss (nominal values) Source: MPF, NTRO, author’s own computations

Under these circumstances, the number of active firms with negative equity has continuously increased in the last years, due to privately owned companies. Inactive firms have also an important contribution to diminishing the capital base in the economy, these cumulating negative equity of -18 billion lei in 2014 (2.7 percent of GDP).

50,000 180,000

45,000 160,000

40,000 140,000

35,000 120,000 30,000 100,000 25,000 80,000 20,000 60,000 15,000

40,000 10,000

5,000 20,000

- - 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 inactive firms, established in the previous 3 years inactive firms, total (rhs)

Figure 11: Number of Inactive Firms Source: MPF, author’s own computations

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Legislative deficiencies, as well as a general undisciplined behaviour, generated some phenomena that can affect the real convergence process. In the last 20 years, the average period in which a firm worked with net losses has been equal to 3 years, while the average survival period has been equal to 6 years. Companies with a fragile economic stance have a higher probability of entering insolvency, this phenomenon being frequently used in our country, although with low efficiency (World Bank, Doing business). Firms newly entered into insolvency proceedings during 2014 have functioned with net losses for 3.2 years in the last 10 years (average values), while the survival period has been equal to almost 5.4 years. These firms were inactive for 2.5 years in the respective period, having negative equity for 3.7 years. In the last years, the structure of firms entering insolvency has been similar to the structure of newly established companies, with the correlation between the two phenomena on an increasing path. At sectoral level (Figure 12), services and trade can be noticed due to i) the largest number of negative equity companies and with net loss as of 2014, ii) the most numerous inactive firms, iii) the highest incidence of insolvent firms and iv) an important volume of shareholders’ loans to their own companies. Particularly, branches such as food trade, consultancy and management, buildings’ construction, road transport of goods or restaurants are characterized by a high frequency of insolvency cases, correlated with a large number of newly born firms, as well as many inactive companies or with losses.

percent 60

50

40

30

20

10

0 Agriculture Industry Constuction Trade Services and Real estate utilities firms with negative equity, 2014 firms with negative equity in the previous 5 consecutive years

Figure 12: Firms with Negative Equity, by Business Sectors (2014) Source: MPF, author’s own computations

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Persistent losses of a large number of economic agents, as well as inadequate capitalization and elevated insolvency incidence significantly contribute to the deterioration of the financial discipline in the economy. The total arrears of active firms with losses and inactive firms have cumulated 9.8 percent of GDP as of 2014 (66 billion lei). After the biggest net losses from 2014, the top 500 companies have accounted for arrears of 23 billion lei (a quarter of total), an important role in generating arrears in the economy being held by insolvent firms. The high value of arrears of undisciplined companies, especially at the consolidated state budget, translates into low investment in infrastructure, institutions, education or health, diminishing potential GDP. Although the elevated number of firms with net losses is a common situation in other peer group countries in the region, Romania is noticed by a higher share of economic agents with profitability problems compared to the EU10 average (Figure 13). Under these circumstances, profitability distribution, as well as other indicators, highlight that Romania is among the countries with the highest inequality between top performers and companies in inferior classes of performance (Figures 14). Microeconomic evidence underlines that an important progress in the real convergence process cannot be obtained unless viable businesses, entrepreneurship and an efficient and performing economic environment are encouraged.

share in employment (percent) 35 LV RO 30

SL SK 25 HU LT BG EE CZ 20 PL 15

10

5

0 0 10 20 30 40 50 share in total number of firms (percent)

Figure 13: The role in the Economy of Firms with Net Losses (2013) Source: Orbis Bureau van Dijk, MPF, author’s own computations

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percent 80

70

60

50

40

30

20

10

0

-10 BG CZ EE HU LT LV PL SK SL RO p25 median p75 average

Figure 14: ROE distribution, Regional Comparison (2013)1 Source: Orbis Bureau van Dijk, MPF, author’s own computations

Firm level developments offer valuable explanations for macroeconomic phenomena. Strategies for promoting export performance must be based on an in-depth understanding of the microeconomic behaviour on macroeconomic results. In formulating solutions for dealing with an external shock, the transmission mechanism of the respective shock at microeconomic level (depending on productivity, firm size, business sector etc.) must be taken into account. Shocks at individual level cannot have an aggregate effect, micro heterogeneity contributing to macro volatility. Therefore, not only that certain firms’ categories with structural problems (losses, low capitalization) have a modest role in export activities, but they also have a negative role on the main external competitiveness price indicators, especially on productivity (Figure 15). Thus, the deficiencies in the external competitiveness and performance of Romania, as reflected by macroeconomic statistics, are explained by firm-level evidence. Low productivity of firms registering losses, as well as the existence of inactive firms on the market for a long time negatively impacts the domestic economy’s price competitiveness.

1 Values obtained after outliers’ eliminations (values below the 1st percentile or larger than the 99th percentile). For greater data comparability, in Romania’s case, the information only takes into account active companies.

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Both the average and median of labour productivity represent around a quarter of the indicators for profitable firms.

thousands RON/ employee 35

30

25

20

15

10

5

0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

active firms, with net losses active firms, with profit

Figure 15: Labour Productivity Evolution (real terms, 2005=100, median values) Source: MPF, author’s own computations Note: Values obtained after outliers’ eliminations. Labour productivity is the ratio between GVA and number of employees.

Net losses companies are involved in external trade activities in a limited number: only 400 firms out of 177,000 active loss companies recorded significant net exports in 2014 (over 100,000 euros in each quarter), while of the inactive firms, none had net exports. On the other hand, these companies are involved in significant or sporadic importing activities, generating a total commercial deficit of 1.9 billion euros. Under these circumstances, the number of firms with a successful business model for export is low, this evolution being manifested also on the grounds of persistent vulnerabilities among the SMEs sector: i) weak profitability (especially in case of microenterprises), ii) reduced capacity of generating GVA and iii) low involvement in exporting. We investigate how firm-level competitiveness indicators’ distribution influences the GVA creation in the economy. Microeconomic analysis of GVA formation highlights a worrying pattern, due to the high degree of concentration of GVA in a limited number of companies. Active loss making firms generated GVA to a low extent (15 percent of total GVA for active

Central Bank Journal of Law and Finance, No. 1/2017 65 The External Competitiveness of the Romanian Economy firms in 2014, Figure 16), with the average GVA per firm of 0.36 billion lei, compared to 1.3 billion lei, the average for profit firms. Moreover, the GVA for loss companies diminished in 2009-2014 by almost a third (compared to a 10 percent reduction for profitable firms in the same period). A relatively important number of firms allocate resources inadequately, generating negative GVA (around 54,000 firms as of 2014, representing 9 percent of total number of companies, cumulate GVA of -2.2 billion lei). Moreover, a significant number of firms (132,000), the majority being inactive, generated a null value of GVA. Thus, in reality, only 414,000 companies out of 600,700 which report to MPF, have the capacity of generating positive GVA.

bln. RON percent 450 30

400 25 350

300 20 250

200 15

150 10 100

50 5 -

(50) 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 inactive companies active firms, with net losses active firms, with profit share in GVA of inactive and loss making firms (rhs)

Figure 16: GVA Evolution according to the Value of Sales and of Net Results (nominal figures) Source: MPF, author’s own computations

The results highlight that only a small part of GVA is further distributed in the economy for labour remuneration and for government lenders. Since 2000, there have been recorded increased discrepancies in GVA allocation, the share of workers’ remuneration decreasing to around 27 percent of GVA, in the favour of capital remuneration, which has roughly been 70 percent of GVA as of 2014.

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Labour costs’ evolution during 2000-2014 indicates that i) loss making firms contributed to the deterioration of economy’s price competitiveness, especially before the crisis broke out, on the grounds of increases in average labour costs (despite the negative profitability and low productivity) and ii) profitable firms recorded an increase in this type of expenses due to more employees. At sectoral level, the most balanced structure of GVA allocation is recorded in industry (with a share of staff remuneration of 32 percent of GVA), the real estate sector being at the opposite end (12 percent of GVA). Corporations and medium-sized enterprises direct GVA to workers to a larger extent than the economy average (over 30 percent), unlike microenterprises, for which labour remuneration represents 22 percent of GVA. A situation more favourable to employees is also recorded for state companies and technology intensive sectors.

bln. RON 16

14

12

10

8

6

4

2

0 Agriculture Industry Construction Trade Services and Real estate utilities GVA growth - simulation 1 GVA growth - simulation 2

Figure 17: GVA Growth Simulations, by Business Sectors (2014) Source: MPF, author’s own computations Note: all companies have non-negative operational results

The reduced capacity of firms to create GVA is generally correlated to a high share of expenditures on goods. By imposing the condition that all the companies in the economy have an expenses’ structure similar to performing firms in the same sector, or assuming that all the firms in the economy generate nonnegative operational profit, the increase in the GVA would have been of maximum 34.5 billion lei as of 2014 (8.4 percent of GVA).

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These simulations highlight the negative impact of unviable firms on potential GDP, their importance in GVA being, however, lower compared to their role in employment (for example, the number of employees of loss making firms was in 2014 of over 962,000, respectively over a quarter of the workforce of active firms).

bln. RON 30

25

20

15

10

5

0 large companies SMEs, out of microenterprises small enterprises medium sized which: enterprises GVA growth - simulation 1 GVA growth - simulation 2

Figure 18: GVA Growth Simulations, by Size (2014) Source: MPF, author’s own computations Note: all companies have the same expenses’ structure as the viable firms (active companies, with positive net result) in the same NACE 2 digits sector.

The potential GVA growth distribution assuming a greater efficiency of economic activity, disentangled by size, sector or ownership, confirms the opportunity cost of maintaining unviable firms in services, trade and industry mostly in microenterprises and domestically owned companies’ categories on the market (Figure 17 and Figure 18). GVA creation concentration in a small number of large firms, mostly foreign, also underlines the necessity for more participants with an important role in the economic activity, which would lead to a higher stability and resilience when facing shocks, increased market size and economic growth.

Improvement in firms’ discipline and competitiveness indicators (especially microeconomic productivity) could generate positive synergies on export capacities,

68 Central Bank Journal of Law and Finance, No. 1/2017 Ana-Maria Cazacu0F external flows’ sustainability and also on the banking sector, state budget and, even further, on the economic growth potential.

4. ROMANIAN FIRMS’ INTEGRATION IN THE GLOBAL VALUE CHAINS

The changing realities of world trade are characterized by a high degree of fragmentation in the production process as well as in consumption, on the grounds of intensifying globalization and gradual removal of tariff barriers, technological progress advance and significant reductions in transportation and communication costs.

Economies, industries and companies became more interrelated, due to the higher connectivity of production stages, together with the increasing volume of trade in intermediary goods, parts, components and accessories. The new paradigm of external trade is characterized by the production network concept, formed of interdependent units, specialized on particular phases of production. In consequence, world trade experiences a shift from trade in goods to trade in tasks, in which each country adds value along the chain in a certain stage of the production process (WTO and IDE-JETRO, 2011).

This produced the replacement of the “made in” assumption with the “made in the world” concept (OECD, 2013). Global value chains (GVC) indicators reflect more accurately external competitiveness, bringing into discussion the multiple counted elements in the traditional statistics of balance of payments which are generally ignored by international trade policies (Koopman et al., 2012). GVC emergence underlines that what a country makes is more important for economic development than what it sells.

Assessing economies’ competitive positions without taking into account this new reality is incomplete, as the gross export values do not offer a loyal picture of the competitive abilities of the nations. The size and complexity of the so-called Global Value Chains was highlighted by the recent economic and financial crisis, when world trade declined by nearly 30 percent in a few months (September 2008-January 2009, Bricongne et al., 2010), due to shocks’ propagation along the chain. Thus, productivity and success on external markets depend not only on exporting abilities but also on the capacity of efficiently importing production factors.

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percent 70

60

50

40

30

20

10

0 SK HU CZ EE SL BG LT PL LV RO Backward participation Forward participation GVC participation index, 1995

Figure 19: GVC Participation of EU10 Countries (2009) Source: WIOD, author’s own computations

Koopman et al. (2012) developed a formal framework for identifying the elements in external trade statistics that are double counted (or even counted multiple times), underlining that exports in value added terms are well below nominal exports, as shown by official statistics, especially in cases when the share of imported inputs used in exporting activity is high. The value added trade refers to the value added created in one country and absorbed in another which can provide a very different image from the one suggested by traditional statistics. Exports can be decomposed in domestic value added, domestic value added returned to the country via intermediate goods imports and foreign value added. The domestic value added is further decomposed in exports absorbed by direct importers and exports used for further re-exporting to third countries. Economies can participate in GVC as users of foreign inputs (“backward participation”) and as suppliers of intermediate goods which are used for exports for other countries (“forward participation”) (ECB, 2014). The total GVC participation index is expressed as a percentage of gross exports and indicates the share of

70 Central Bank Journal of Law and Finance, No. 1/2017 Ana-Maria Cazacu0F foreign inputs used in exports and domestically produced inputs used in third countries’ exports. The results obtained by decomposing Romania’s export flows in value added flows (according to the abovementioned methodology) suggest that Romania is at the bottom of EU10 top as far as the import content of exports is concerned (“backward participation” in GVC). This means that imported goods are mostly used for domestic production or consumption, thus fuelling the external trade deficit. On the other hand, Romania has one of the highest percentages of exported goods and services that are used as imported inputs to produce other countries’ exports (suggesting an intensive “forward participation” in GVC). This means that a large part of Romanian exports is not absorbed by direct importers, but rather further used in exporting to third countries. This evidence might indicate that Romania is at the incipient stages of the GVC, exporting raw materials rather than selling final goods. Overall, Romania is placed at the bottom of the EU10 countries regarding GVC integration, Figure 19. Nevertheless, GVC participation index increased during 1995-2009, indicating an increase in the vertical specialization of production. The situation is common for most of the analysed countries. Romanian companies’ exports do not imply a large degree of complexity, as also reflected by the low share of services in Romania’s total value added exports.

percent 70

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50

40

30

20

10

0 LV EE BG SL PL LT HU CZ SK RO

value added flows gross flows

Figure 20: Role of Services in Total Exports (2009) Source: OECD, WTO Trade in Value Added

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GVC indicators show that services’ role in exports is underestimated by standard trade indicators, but even under these circumstances, Romania has the lowest share of services in exports’ value added among the EU (less than 40%, Figure 20). Taking into account that Romania did not optimally benefit from the global value chains’ synergies, ameliorating this situation should constitute a priority for the authorities, as a better integration in the production chains could provide Romanian firms with additional export opportunities. This is also supported by the present situation which indicates an elevated export concentration in industries characterised by a high integration in global value chains. The abovementioned results are in line with the previous findings, showing that domestic firms are unfavourably placed in the incipient part of the production chains (upstream participation) as a natural consequence of low technological and sophistication business model, reduced productivity for an important share of companies and economic activity concentration. As long as exporting does not imply a high degree of knowledge, the opportunities for importing technology, know-how or for increasing productivity due to exports diminish.

5. POLICY OPTIONS

Based on the indicators for the different facets of competitiveness, we formulate possible policy measures for the legislative and business environment, for fiscal efficiency or solving structural problems. All these measures aim to increase domestic firms’ capacity (and implicitly that of the national economy) of competing on the external market by assuring an adequate framework for a good development of the economic activity, for the punishment of undisciplined agents and for a pillar of national economy competitiveness and attractiveness. Evidence related to subdued profitability and high frequencies of insolvencies, including of newly established firms, signals that new businesses should be encouraged on a sustainable basis. Thus, in order to establish a society, entrepreneurs should take specialized courses and an exam based on which they can become firms’ administrators. Early entrepreneurial education is also essential for a future revival of the business environment. Fiscal inspections should be mainly directed towards the categories of firms which display a high risk of evasion, namely those companies i) with a high probability of using black labour, having a low share of employees’ remuneration in GVA (mostly microenterprises), ii) which activate in specific domains with a high insolvency frequency correlated to the establishment of new firms and a large number of inactive or loss making companies (food trade, buildings’ construction, restaurants, bars etc.), iii) which are multinationals’ subsidiaries and record large losses in Romania due to affiliated entities’ transactions; this kind of evidence can be a lead for detecting cases of profits’ transfer in the country of origin of the parent company or of profit shifting (the profit is moved to countries with a more favourable tax regime).

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A greater efficiency of the insolvency process through rapid and objective solving of insolvencies, prevention of inadequate usage of procedural mechanisms and identification and sanctions applied to bad practices cases in the insolvency field could contribute to increased firms’ and creditors’ trust that this procedure can act as a satisfying instrument for solving financial difficulties, namely for a more efficient manner of recovering debt. A deficiency of the current system is the elimination of a series of sanctions applied to debtors’ representatives, judicial administrators or liquidators that act in bad faith. Compared to Law 85/2006, the new insolvency code eliminated some provisions that imposed sanctions for debtors’ representatives, administrators or liquidators who do not observe the deadlines for introducing the insolvency request, who refuse to offer information or provide wrong data, dismantle assets or rights from insolvent debtors’ patrimony or commit misappropriation facts. Under these circumstances, provisions must be introduced for reducing potential abuses, including the usage of the insolvency process as a means of fiscal evasion (insolvent companies have had, up to the present, an important role in generating arrears to state budget). Communication and publicity system in insolvency field can be improved by i) publishing the major cases of agents for which insolvency is opened in national wide circulation newspapers, ii) creating a centralized database with information on all insolvent companies (the current phase) or all companies that enter insolvency, as well as data on administrators/shareholders that are proven to have acted in bad faith or illegally. For increasing business discipline, policy makers could offer deductions for timely payments or issue increased penalties for delays or for not observing contractual clauses/commitments, especially for large taxpayers. For improving economy-wide performances and for long term sustainability of the current account, it is necessary to solve firm-level difficulties. Most Romanian companies (especially those with domestic capital) do not have other competitive strategies than low costs, to the detriment of increasing productivity and diminishing technological and know how gaps. Increasing Romanian exports’ sophistication level through i) production process modernization of domestic firms by means of increasing productivity, ii) product upgrading through a larger specialization in high value added goods, as well as iii) the progress of domestic firms to more advanced production phases (projection, design, services associated with the final good, marketing, branding) or knowledge intensive sectors could contribute to competitiveness gains for Romania and to moving towards superior phases in the global value chains. In this respect, helping firms to create their own brand - for example by reimbursing costs with employees, machines and equipment, research and development etc. -, simultaneously with an adequate quality of domestic products, could allow national companies to compete by this kind of elements and not by price mostly (as in the present), with beneficial effects on profitability and capacity of facing unfavourable developments. Fiscal incentives offered to firms which effectuate innovation and research and development expenses could have a role in the transition process from a price based competitiveness economy towards an economy based on non-price competitiveness, centred on innovation.

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Stimulation of public-private partnerships in research, a better collaboration between companies and universities, especially in the industrial field, would be a useful tool in this respect, based on the empirical evidence linked to the industry’s capacity of generating GVA to a greater extent than other economic sectors. On the other hand, taking into account the low capacity of creating GVA of trade sectors and the high number of economic agents from this sector, one could highlight the need to discourage the creation of new firms and the persistence of unprofitable firms in this area, in favour of creating coherent production chains, with high quality services to amplify industrial capacities. Advancing to superior phases in the production chain implies focusing on endowments such as capital, technology and knowledge. In this respect, measures with positive impact on firms’ capacity of generating GVA and on their productivity could focus on increasing capital stock and reducing its age, for example, by encouraging investment (both domestic and foreign); the low stock of capital, as well as low R&D expenses, slows the innovative capacities and technological progress needed for sustained productivity gains. Solving some structural problems has to be a priority in order to increase Romania’s competitiveness and productivity, through: . increases in employees’ level of qualification (including vocational) and a better correlation with market demands; improving staff skills would contribute to an increase in productivity and gross value added; . improvements in public institutions’ quality and investments in infrastructure, with positive effects especially in hardly accessible and underdeveloped regions; . commercial, fiscal and accounting legislation’s improvement, including through the alignment with the European standards; this would contribute to diminishing the risks from companies’ sector and to avoiding misconduct (Georgescu, 2015); . business environment regulation, by reducing bureaucracy and simplifying procedures applicable to firms (licensing, tax payments, insolvency); . increases in predictability level of national legislation. We present a comprehensible framework of external competitiveness assessment for domestic firms, by analysing, beyond any traditional macroeconomic competitiveness indicators, the fundaments derived from firm-level evolutions that determine the aggregate behaviour. The corroboration of both approaches offers valuable explanations for domestic economic agents and fundaments their position along regional production chains. The present evidence allows the identification of the main challenges for the next period, namely i) improving Romanian firms’ performances and financial discipline, ii) consolidating medium and long term exporting capacity, iii) improving the general business environment and iv) positioning the national economy towards superior phases within the global value chains (by improving non-price, efficiency and innovation competitiveness factors).

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16. Cazacu (Bancu) A.M., 2015c, Fiscal-monetary policy interaction. SVAR Evidence from a CEE country, European Scientific Journal, vol. April 2015, nr. Special Edition, pg. 12-23, ISSN 1857-7881 17. Cazacu (Bancu) A.M., 2015d, Global Competitiveness Index and economic growth, Theoretical and Applied Economics, vol. XXII, issue Special(II), pages 369-373 18. Cazacu (Bancu) A.M., 2015e, Price and non-price factors and economic development. A PVAR approach, European Scientific Journal, vol. 11, no. 13, pages 71-86, ISSN 1857-7881 19. Cazacu (Bancu) A.M., 2015f, SMEs contribution to the economy and their access to bank financing in Romania and other European countries, ENTIME (Enterprise(s) in modern economy) Conference, Gdańsk University of Technology, Poland, Social, innovative and financial dimensions of enterprising organizations, ISBN 978-83- 62197-49-1, [online], Available at http://zie.pg.edu.pl/documents/40289460/520aca7a-2ade-4657-bc41- a02d71c98035 20. De Loecker, J. 2007, Do Exports Generate Higher Productivity? Evidence from Slovenia, Journal of International Economics 73, 69–98. 21. Di Mauro, F. and Forster, K., 2010, Globalisation and the competitiveness of the Euro area, Department of the Treasury, Ministry of Economy and Finance, Working Papers No. 5 22. ECB, 2014, Global Value Chains reshape our policy thinking, CompNet Policy Brief no. 6 23. Ezeala-Harrison, F., 1999, Theory and policy of international competitiveness, London: Praeger 24. Georgescu, F., 2002, Starea economico-socială a României în anul 2000, Editura Expert, ISBN 978-973-8177-71-0 25. Georgescu, F., 2010, Politicile economice ale României în scopul adoptării euro, [online], Available at http://www.bnr.ro/files/d/Noutati/Prezentari%20si%20interviuri/R20101215FG.pdf 26. Georgescu, F., 2013, Alocuţiune de deschidere la conferința Competitivitatea României, [online] Available at http://www.bnr.ro/Alocutiune-de-deschidere-la- conferinta-Competitivitatea-Romaniei-10132.aspx 27. Georgescu, F., 2015a, Disciplina financiară și creșterea economică, mimeo BNR 28. Georgescu, F., 2015b, Disciplina financiară și stabilitatea financiară, [online], Available at http://www.bnr.ro/files/d/Noutati/Prezentari%20si%20interviuri/2015/R2015072 4FG.pdf 29. Georgescu, F., 2015c, Growth, ageing and income distribution in Romania, [online], Available at http://www.bnr.ro/files/d/Noutati/Prezentari%20si%20interviuri/2015/R_E20150 530FG.pdf 30. Georgescu, F., 2015d, Capitalul în România anului 2015, Prelegere susținută la decernarea diplomei „Virgil Madgearu” cu medalie de aur 31. Georgescu, F., 2016a, Limitele globalizării și ale dereglementării, Dizertație susținută la Universitatea din Craiova cu ocazia decernării titlului de Doctor Honoris Causa

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32. Georgescu, F., 2016b, Creșterea economică, dezvoltarea României și reducerea sărăciei, Prezentare susținută în cadrul Conferinței "Dezvoltarea României și politicile anti-sărăcie", organizată de SNSPA 33. Hausmann, R., Hwang, J. and Rodrik, D., 2007. What You Export Matters, Journal of Economic Growth 12(1): 1–25 34. Hausmann, R., Hwang, J. şi Rodrik, D., 2007. What You Export Matters, Journal of Economic Growth 12(1): 1–25 35. Hesse, H., 2008, Export diversification and economic growth. Commission on growth and development working paper; no. 21. Washington, DC: World Bank. [online] Available at: http://documents.worldbank.org/curated/en/577921468150573677/Export- diversification-and-economic-growth 36. Holtz-Eakin, D., Newey, W. and H. Rosen, 1988, Estimating Vector Autoregression with Panel Data. Econometrica, 56, 1371-1395, 1988 37. Hummels, D. and Klenow, P.J. 2005, The Variety and Quality of a Nations Exports, American Economic Review, No. 95 38. Hummels, D., Ishii, J. şi Yi., K., 2001, The Nature and Growth of Vertical Specialization in World Trade. Journal of International Economics, 54, pp. 75–96. 39. Ilzkovitz, F.,Dierx, A., Galgau, O. and Leib, K., 2008, Trade Performance and Structural Competitiveness Developments in the Euro Area: Are Member States Equipped to Meet the Globalisation Challenges of the 21st Century? Paper - 35 - presented at the Workshop: The Implications of European Integration, Federal Reserve Bank of St. Louis and the European Union Studies Association, Mai 2009. 40. Koopman, R., Wang, Z. şi Wei, S.J., 2012, The Value-added Structure of Gross Exports and Global Production Network [pdf] Available at http://www.ecb.europa.eu/home/pdf/research/compnet/WIOD-2012- USITC.pdf?e2444d4b8d94e9f056f93bab51df5fff 41. Krugman, P., 1994, Competitiveness: A dangerous obsession, Foreign Affairs, 73(2), pp. 28-44 42. Melitz, M.J. 2003, The impact of trade on intra-industry reallocations and aggregate industry productivity, Econometrica, 71(6) 43. Mihai, I. and Tarţa, A., 2015, The role of the insolvency framework in strengthening payment discipline and in developing the credit market in Romania, Central Bank Journal of Law and Finance, no. 2/2015 44. NBR, Financial Stability Reports, [online] Available at: http://www.bnr.ro/PublicationDocuments.aspx?icid=19968 45. Neagu, F., Dragu, F. and Costeiu, A., 2016, După 20 de ani: schimbări structurale în economia României în primele decenii postdecembriste, Caiet de studii nr. 42 BNR 46. Neagu, F., Dragu, F. and Costeiu, A., 2017, Pregătiți pentru viitor? O nouă perspectivă asupra economiei României, Caiet de studii nr. 46 BNR 47. Nkusu, M., 2013, Boosting Competitiveness to Grow Out of Debt—Can Ireland Find a Way Back to Its Future?, IMF Working Paper 13/35 48. OCDE, 1992, Programme on Technology and the Economy, OECD

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49. OCDE, 2013, Interconnected economies: benefiting from Global Value Chains. OECD publishing http://dx.doi.org/10.1787/9789264189560-en 50. Porter, M., 1990, The Competitive Advantage of Nations, New York, NY: Free Press. 51. The Competitiveness Research Network, 2014, Micro-based evidence of EU competitiveness. The CompNet Database, ECB Working Paper 1634, ISSN 1725-2806 52. Văcărel, I. and Georgescu, F., 2007, Finanțe Publice, Editura Didactică și Pedagogică 53. World Bank, database, Available at http://databank.worldbank.org/data/home.aspx 54. World Economic Forum, 2014, Data base, [online] Available at: http://reports.weforum.org/global-competitiveness-report-2014-2015/downloads/ 55. WTO and IDE-JETRO, 2011, Trade Patterns and Global Value Chains in East Asia: From trade in goods to trade in tasks. [online] Available at http://www.wto.org/english/res_e/booksp_e/stat_tradepat_globvalchains_e.pdf

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The Impact of MiFID II on the Liquidity of Fixed Income Instruments

Andreea Oprea*

Abstract

Trading in financial markets has been continuously changing and much more is to be seen. There are some factors determining this flashing dynamism: technological development and more sophisticated products or regulations just to name a few. However, how serious do things turn when having to deal with what was considered the largest and most complex piece of legislation ever to hit global financial services (Mark Holmes, Waymark Tech)? The EU’s second Markets in Financial Instruments Directive (MiFID II) aims – among other things – to increase transparency in financial markets; but at what cost? –this is what most dealers are actually concerned about. Given the complexity of its products, there is a market that might experience change at a much more intense level than others will: it is the bond market, which due to its wide range of issuances, structures, credit qualities and maturities might not do well when trying to accommodate to the new transparency requirements. The major issue that arises – and which we addressed in this article – refers to the impact that MiFID II might have on the liquidity of fixed income instruments.

Keywords: MiFID II, fixed income, bond liquidity, primary market, secondary market, trading venues, systematic internaliser, organized trading facility, multilateral trading facility, OTC, dealing on own account, order execution, transactions matching

JEL Classification: G15, G18, K22

* Graduated of the Doctoral School of Finance and Banking (DOFIN) MS programme (2016); Economist at the National Bank of Romania, Market Operations Department, Treasury Operations Division; former Corporate and Retail Sales Trader in the Treasury and Financial Market Division of Piraeus Bank Romania

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LIST OF ABBREVIATIONS AND DEFINITIONS

APA Approved Publication Arrangement BME Bolsas y Mercados Españoles COFIA Classes of Financial Instruments Approach CP Client Portals Dealing on Trading against proprietary capital resulting in the conclusion of own account transactions in one or more financial instruments (Article 4(1)(6), MiFID II Regulation) DG FISMA Directorate-General for Financial Stability, Financial Services and Capital Markets Union ECMI European Capital Markets Institute EMIR European Market Infrastructure Regulation EOB Electronic Order Book ESMA The European Securities and Markets Authority IBIA Instrument By Instrument Approach IF Investment Firm ISIN International Securities Identification Number LIS (trades) Large-in-scale (trades); orders that are large in scale compared with normal market size Matched A form of dealing on own account where a firm executes client principal orders by standing between clients on a matched principal basis trading (back-to-back trading), it is both dealing on own account and executing orders on behalf of clients (Financial Conduct Authority, Markets in Financial Instruments Directive II Implementation - Consultation Paper I (CP15/43), December 2015, CP15/43, p. 262); under MiFID II, matched principle trading is defined as a transaction where the facilitator interposes between the buyer and seller to the transaction in such a way that it is never exposed to market risk throughout the execution of the transaction, with both sides executed simultaneously and the transaction is concluded at a price where the facilitator makes no profit or loss, other than a previously disclosed commission, fee or charge for the transaction MiFID Markets in Financial Instruments Directive MiFIR Markets in Financial Instruments Regulation MTF Multilateral Trading Facilities; multilateral system, operated by an investment firm or a market operator, which brings together multiple third-party buying and selling interests in financial instruments - in the system and in accordance with non- discretionary rules in a way that results in a contract in accordance with the provisions of Title II of MiFID II. NCA National Competent Authority

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Non- The investment firm operating an MTF has no discretion as to how discretionary interests may interact. Interests are brought together by forming a rules contract and the execution takes place under the system's rules or by means of the system's protocols or internal operating procedures. The MTF can be operated by a market operator or an investment firm whereas the operation of a regulated market is not considered an investment service and is carried out exclusively by market operators that are authorised to do so; There are two types of investment accounts: discretionary and non-discretionary. A discretionary account is one that allows a broker to buy and sell securities without the client’s consent. However, they must still make decisions in accordance with the clients’ stated investment goals. A non-discretionary account is one where the client makes all the trading decisions. With these types of accounts, the broker’s job is simply to receive and execute the clients’ requested trades, and try and get the best price possible. The broker may still make recommendations on what to purchase, but they will not make these purchases without first getting the investors’ consent. (https://investoradvocacyclinic.wordpress.com/2014/04/01/discre tionary-vs-non-discretionary/) Order Takes place when a broker receives a buy and sell order for the same crossing asset at the same price, and subsequently makes a simultaneous trade between two separate customers at that price OTC Over-the-counter; a decentralized market, where participants trade with one another on a bilateral basis, via telephone, email or proprietary electronic trading systems, without the supervision of an exchange OTF Organized Trading Facility; a multilateral system which is not an RM or an MTF and in which multiple third-party buying and selling interests in bonds, structured finance products, emission allowances or derivatives are able to interact in the system in a way that results in a contract in accordance with the provisions of Title II of MiFID II. Proprietary Occurs when a firm or bank engages its own money (proprietary trading (prop capital) instead of earning commission dollars by trading on behalf trading) of its clients. This type of trading occurs when a firm decides to profit from the market rather than from the thin-margin commissions it makes from processing trades QE Quantitative Easing RFQ Request-for-quote RM Regulated Market; a multilateral system operated by and/or managed by a market operator, which brings together or facilitates the bringing together of multiple third-parties buying and selling interests in financial instruments in the system and in accordance with its non-discretionary rules in a way that results in a contract, in respect of the financial instruments admitted to trading under its rules and/or systems, and which is authorised and functions regularly and in accordance with the provisions of Title III of MiFID II

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SDP Single Dealer Platform SI Systematic Internaliser; an investment firm which, on an organised, frequent systematic and substantial basis, deals on own account by executing client orders outside an RM, MTF or OTF without operating a multilateral system (MiFID II) SSTI Size specific to instrument; actionable indications of interest in request-for-quote and voice trading systems that are above a size specific to the financial instrument, which would expose liquidity providers to undue risk and take into account whether the relevant market participants are retail or wholesale investors Waivers MiFID allows competent authorities to waive the obligation for operators of RMs and MTFs regarding pre-trade transparency requirements for shares based on the market model or the type and size of orders. MiFID allows competent authorities to grant four types of waivers, which are contained in Articles 18 and 20 of MiFID Implementing Regulation. Possible waivers apply to reference price systems, negotiated trade systems, order management facilities, and large-in-scale transactions

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1. POTENTIAL ISSUES ARISING FROM MiFID II

The improvement that the latest Markets in Financial Instruments Directive (MiFID II) is expected to have on pre- and post-trade transparency comes with a cost, as most traders and analysts believe the regulation will negatively impact the liquidity on the bond markets. In a conference held at the European Capital Markets Institute (ECMI) in Brussel, Jorge Yzaguirre Scharfhausen from Bolsas y Mercados Españoles (BME) specified that the new transparency regime was expected to weigh on about 50% of the private bond operations, 50% of the public debt trades executed between entities and basically on all of the public debt operations executed with third parties. He added that in terms of digits, only 2% of the currently ISINs traded on the market can be classified as liquid, while the remaining 98% are illiquid instruments; still, the transactions with liquid assets account for approximately 90% of the total traded volume. In the case of BME, after clearly delimiting the Systematic Internalisers, the large-in-scale (LIS) trades above a certain size and the ones that are below a size specific to instrument (SSTI) will be routed to an electronic order book (EOB), while the transactions below LIS and above SSTI will reach a request for quote (RFQ) platform. As a final step, BME intends to include European sovereign and corporate bonds and also to target fixed income instruments belonging to Spanish companies listed on other exchanges in particular. Bas Dommerholt, supervisor at the Netherlands Authority for the Financial Markets addressed the issue of liquidity with more optimism. He suggested that more economies of scale should be engaged in the trading of fixed income instruments, so that liquidity providers would have access to a wider range of clients; therefore, he emphasized the role that a more transparent regime would have in breaking some boundaries between clients and liquidity providers, especially in the case of non-professional investors. Nevertheless, given the regulatory burden and the fact that at the moment of writing many aspects remain unclear, Dommerholt’s idea can only be judged at a theoretical level for instance. Another speaker who showed concern for the impact that Mifid II would have on bond liquidity was Julian Allen-Ellis, director at the Association for Financial Markets in Europe, specialized in MiFID/MiFIR. He affirmed that the transformations the regulation could generate in technology, operations and staff, might create a gap between large players – who will be able to adapt to them – and the rest of the market participants who will most probably struggle. Regarding the measures imposed by MiFID II, Per Loven – commercial director at TRADEcho – specifies that transparency is necessary […] but transparency just for the sake of transparency itself does not necessarily bring any

Central Bank Journal of Law and Finance, No. 1/2017 83 The Impact of MiFID II on the Liquidity of Fixed Income Instruments gains1. Per Loven also emphasized the difference of approach between retail and institutional investors, in the sense that while pricing disclosure might be important for the former, for the latter, the depth to liquidity is more important. Moreover, bond market is largely an Institutional Market, as fixed income instruments are typically held by institutions. While businesses use short-term papers for cash management, large holders such as pension funds, insurance companies and central banks engage in long-term investment contracts. In the case of both pension funds and insurers, reserves generally go in low-risk investments, most often in the form of government securities. Insurers set aside the amount of funds that is not invested, so that firms can immediately have access to urgent claims. In terms of statistics, the participation of retail investors in the European bond market only accounts for about 10%2. Therefore, markets remain reliant on the fully functioning of the institutional model to fulfil the growing long-term funding requirements.

2. PRIMARY VS. SECONDARY MARKET

In contrast with equities, where the volumes on secondary markets clearly outweigh the capital that flows directly towards issuers, fixed-income instruments are tightly related to primary market issuance. The relationship between primary and secondary market is crucial when it comes to the bond market, as issuers find it more difficult to submit a new debt in the lack of an active secondary market. The government bond market represents an example of the aforementioned critical link, where issuers rely on market markers to provide continuous flows. Given the specificities of each asset, the way the fixed-income market operates differs fundamentally from the way the equity market functions (Fig. 1). The equity market structure, for example, is based on an exchange model; the equity market is an order- driven market, where brokers route orders to exchanges for matching. Unlike equities, bonds are traded mainly via a quote-driven OTC bilateral system, as the diversity of issuances, structures, maturities and credit qualities makes it extremely challenging to match buy and sell orders, especially at the same size and price. When trading bonds, a dealer should engage two forces in order to reduce the market risk generated by holding inventory: a sales force in charge of finding clients and a trader in charge of holding the security until a buyer is found.

1 ECMI-CEPS Seminar, 6 April 2017 Brussel, Unravelling Ariadne’s MiFID II Thread: Pre- and post- trade transparency for non-equity markets 2 Healey, R., (July 2012), MiFID II and Fixed-Income Price Transparency: Panacea or Problem?, Tabb Group, Global Fixed Income Division, p. 18

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Due to advances in automation, there is a wide range of market models designed for order execution.

Figure 1: Order Execution Market Models Source: Tabb Group, Global Fixed Income, MiFID II and Fixed-Income Price Transparency: Panacea or Problem?

Apart from the two aforementioned models, there is the order book, which represents an electronic order book scheduled for real-time electronic matching. Given the diversity of fixed income instruments and the liquidity issues derived from it, the order book does not prevail in the dealer-to-client market. However, many interdealer broker platforms function in a way similar to the order book. As investors grew more sophisticated, so the number of MTFs (multilateral trading facilities) increased. MTFs provide their users – largely institutional investors – with access to a wider number of market participants and prices. Article 4 (15) from MiFID Regulation defines MTF as a multilateral system, operated by an investment firm or a market operator, which brings together multiple third-party buying and selling interests in financial instruments – in the system and in accordance with non- discretionary rules 3– in a way that results in a contract. As the regulatory regime from MiFID I generated some competitive distortions – since there were easier conditions for MTFs than for Regulated Markets (RM), MiFID II had to correct those imbalances. As a

3 See Appendix 1. Abbreviations and Definitions

Central Bank Journal of Law and Finance, No. 1/2017 85 The Impact of MiFID II on the Liquidity of Fixed Income Instruments repercussion, organizational requirements for MTFs are currently comparable with those applied to RMs and all trading venues, including OTFs (organized trading facilities) which should be subject to identical pre and post trade transparency rules. However, while electronic platforms may be appropriate for liquid instruments such as the government debt, the distribution of electronic prices is not suitable for all orders or products. Moreover, not all government debt instruments have the same underlying credit risk, so they might require different methods of order execution. To sum up, the way the bond market will react to the new regulatory changes imposed by MiFID II tightly relates to the connection between primary issuances and transactions on secondary market, and implicitly to the way liquidity on fixed income instruments would be addressed. The diversity of features on the bond market makes it subject to a wide range of order execution models, which will also have to adapt to the new regulatory regime, as there are plenty of novelty elements in terms of trading venues.

3. ORDER EXECUTION AND TRADING VENUES

We displayed in the diagrams below the main order execution models used for fixed- income instruments. The Dealer-to-client model is split into two subcategories, the SDP and client portals (CPs) and the Multi-dealer RFQ platforms:

Dealer-to- Dealer-to- client model dealer

SDP and Client Portals (CPs)

Multi-dealer RFQ platforms

Figure 2: Main order Execution Models used in Trading Communication between dealers and clients can take place via voice or electronically, throughout single-dealer platforms (SDPs), clients portals (CPs) or multi-dealer platforms (MDPs). SDPs and CPs are distinct for each dealer and provide customers with valuable tools to trade, such as analytics and research material. With CPs, clients can access dealers’ quotations by using secured dealer pages, on trade platforms such as Bloomberg, Reuters or via a bank’s own website. Quotations are provided on request and can be indicative or firm depending on the liquidity of the traded

86 Central Bank Journal of Law and Finance, No. 1/2017 Andreea Oprea instrument. SDPs are proprietary platforms where dealers can commit their own capital to match clients’ orders. Therefore, depending on the liquidity of the product, prices can be either firm or indicative, established both via click-and-trade and via RFQ (request for quotation) methodology4. The second subcategory is represented by the Multi-dealer RFQ platforms, throughout which market makers provide two-sided quotations upon request, taking into account the order specifications and the settlement risk implied by each client. The dealer-to-dealer model employs interdealer brokers (IDBs), which allow market makers to offload positions resulted from clients’ transactions. By facilitating the hedging transactions between market participants, interdealer brokers contribute to the overall liquidity of the market. In the bond market, liquidity boosters are of major importance given the limited availability of hedging instruments. Interdealer brokers are more common for instruments such as sovereign debt rather than corporate bonds. When addressing the order execution problem, it is essential to understand the concepts that MiFID II introduces in terms of trading venues. There are currently three trading venues defined under the legislation: the regulated market (RM), the multilateral trading facility (MTF) and the organized trading facility (OTF) – see definitions in Appendix 1. While the first two venues existed in MiFID I, the OTF was introduced by MiFID II and differs from MTFs from some perspectives, which will be discussed later on. What these three entities do have in common is the fact that transactions take place multilaterally, in contrast with the OTC market where market participants engage in bilateral deals. In terms of trading venues, there were two main specific problems encountered in MiFID I – which MiFID II intends to correct: First, MTFs may be subject to a less stringent supervisory and regulatory regime in practice, although they provide services that are comparable to the ones from regulated markets. While the introduction of MTFs had its role in increasing the competition between trading venues, it also led to a market fragmentation and implicitly to a more difficult data collection process. With MiFID II, the European Commission aims to align the conditions for MTFs with those imposed to RMs in order to facilitate a more level playing field. Second, new trading venues and market structures that perform activities which are comparable to the ones carried out by MTFs and SIs (Systematic Internalisers) have emerged and are active (such as broker crossing systems or derivative trading platforms), but are not subject to the same regulatory regime and do not fulfil the same transparency and investor protection requirements5. Unlike MTFs, OTFs may only trade in non-equity instruments (bonds, structured finance products, derivatives and emission allowance).

4 Healey, R., (July 2012), MiFID II and Fixed-Income Price Transparency: Panacea or Problem?, Tabb Group, Global Fixed Income Division, pp. 24-25 5 Global training, Part of University of Nicosia, MiFID II (prepared by Olivia Parpa), presented at the Romanian Institute of Financial Studies, pp. 17- 18

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The extent to which investment firms will prefer to operate OTFs instead of MTFs in respect of bonds remains to be seen. On the one hand, OTFs benefit from the opportunity to apply discretion, which might be appealing up to some point. On the other hand, unlike MTFs, they will have to comply with investor protection obligations under articles 24 (regarding information to clients), 25 (suitability), 27 (best execution) and 28 (client order handling). Therefore, given the regulatory burden, investment firms might also decide upon reconfiguring their platforms to make them non-discretionary, rather than having to comply with so many additional investor protection rules. For example, Article 24 requires investment firms – among other things – to act honestly, fairly and professionally in accordance with the best interests of its client, for all information addressed to clients to be fair, clear and not misleading, and all costs and charges to be aggregated to allow the client to understand the overall cost as well as the cumulative effect on return of the investment; all these might sound a little bit too much for the well- functioning of a business, as a large amount of time resources would be allocated to the clients’ full dissemination of information. Under MiFID II, all the three aforementioned trading venues will be subject to the same transparency requirements, calibrated for different types of products; also, they will have to adapt to new requirements regarding circuit breakers, system resilience and electronic trading and tick size regimes that are intended to address risks derived from algorithmic trading and direct electronic access6. The key differences between trading venues are summarized in the table below and detailed afterwards:

Table 1: Key Differences between Trading Venues

Regulated Market MTF OTF Financial Equity and non- Equity and non- Non-equity only instruments equity equity Execution of Non- discretionary Non- discretionary Discretionary transactions Proprietary Prohibited, with Prohibited Prohibited capital exceptions Matched Permitted in principal Prohibited Prohibited some cases with client trading consent Permitted with respect Own account to illiquid sovereign Prohibited Prohibited trading debt instruments Source: Linklaters, MiFID II: The new market structure paradigm

6 Bernard, C. (2014), MiFID II: The new market structure paradigm, Linklaters, p. 3

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Regarding the execution of transactions, unlike MTFs and RMs that are characterized by non-discretionary execution rules, orders on an OTF will be carried out on a discretionary basis. OTF operators may, therefore, decide the time and the size at which two or more orders will be matched within the system. OTFs are allowed to exercise discretion under the following circumstances: (i) when deciding to place or retract an order on the OTF they operate; (ii) when deciding not to match a specific client order with other orders available in the systems at a given time. For platforms where non-equity instruments are being traded, the investment firm could facilitate the negotiation process between customers, by bringing together potentially compatible trading interests. Given that OTFs are subject to discretionary rules for the execution of transactions, they must also be compliant with the conduct of business, investor protection and must provide their clients with the best execution practices. All trading venues must ensure transparent and non-discriminatory access to their participants or clients (RMs and MTFs have members or participants, OTFs have clients), based on objective criteria. RMs and MTFs will continue operating under similar requirements in regard to which they may accept as members or participants. OTFs have the option to determine and restrict access, depending on the role and obligations they detain in relation to their clients7. It is a fine distinction that we have to make between what discriminatory and non-discriminatory means in terms of order execution and trading venue access when it comes to OTFs: OTFs do have to provide non-discriminatory access to clients, but on the other hand, they execute orders based on a discriminatory basis. To some extent, trading venues have the freedom to specify parameters governing the system for their participants or clients – as for example minimum latency – with the sole condition to do so in an open and transparent manner. Another key difference between the aforementioned trading venues lies in the use of proprietary capital in the execution of orders and the matched principal trading. Neither Regulated Markets, nor Multilateral Trading Facilities are allowed to engage in proprietary trading8 or matched principal trading9. In addition, Organized Trading Facilities may not use the proprietary capital of the operator or of any other entity belonging to the same legal person or corporate group. Still, OTFs may use matched principal trading when it comes to bonds, emission allowances, structured products and derivatives that do not fall under the clearing constraints of Article 5 of EMIR10.

7 Bernard, C. (2014), MiFID II: The new market structure paradigm, Linklaters, p. 3 8 Idem. 3 9 Idem. 3 10 Idem. 3

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Moreover, they are allowed to deal on own account11 when it comes to illiquid sovereign debt instruments. An OTF operator who engages in matched principal trading has the obligation to justify the action in front of the relevant competent authority, which will analyse the former’s activity and ensure that it does not lead to conflicts of interest between the OTF and its clients. Another feature of an OTF is that it cannot function as a systematic internaliser (SI). Furthermore, an OTF may not establish any connection with a SI, if this connection has the power of enabling orders or quotes to interact. The Organized Trading Facility may hire another investment firm as a market maker, only on an independent basis and under the condition that the OTF and the investment firm are not closely related.

4. SYSTEMATIC INTERNALISATION AND LIQUIDITY ASSESSMENT

The introduction of rules for determining whether an entity should be classified as a systematic internaliser (Sis) for a certain instrument represents one of the biggest challenges brought by MiFID 2. Systematic Internalisers are not trading venues, as they do not bring together multiple third parties buying and selling interests; unlike RMs, MTFs and OTFs, they trade bilaterally on OTC12 markets and execute client orders against their own proprietary capital. Any dealing on own account with clients is considered an OTC and will usually meet the SI definition – unless it is done irregularly and non-systematically. Therefore, not all transactions concluded by members, participants or clients of an RM, MTF or OTF should be considered within the perimeter of a trading venue. In case these transactions are performed on a bilateral basis or in case the players do not cumulatively fulfil the obligations established for RMs, MTFs or OTFs, they will be considered outside a trading venue. MiFID 2 defines a systematic internaliser as an investment firm, which, on an organized, frequent, systematic and substantial basis, deals on own account by executing client orders outside a RM, MTF or OTF without operating a multilateral system13. The Regulation set thresholds to define and measure the frequent, systematic and substantial basis, but those that do not fall within the thresholds can also opt in under the SI regime. The frequent and systematic basis is captured by the number of trades per instrument that are concluded by the investment firm on own account by executing client orders. As for the substantial basis condition, the Regulation provides two criteria to measure it: the first is the weight of the OTC transaction volume carried out by the investment firm in

11 Idem. 3 12 Idem. 3 13 Idem. 3

90 Central Bank Journal of Law and Finance, No. 1/2017 Andreea Oprea the total volume traded by the investment firm for a specific financial instrument; the second is the weight of the OTC traded volume performed by the investment firm in the overall volume carried out in the European Union for that specific instrument. All conditions must be fulfilled cumulatively in order for an investment firm to satisfy the SI definition. Systematic internalization applies per instrument. In the case of bonds, it applies per ISIN:

Threshold Formula/Condition Frequent and systematic basis (for liquid instruments)

Frequent and systematic basis (for Minimum trading frequency (during the last 6 illiquid instruments) months) Substantial basis (criteria 1)

Substantial basis (criteria 2)

As we can observe from the formulas above, the specific thresholds’ calculations used to determine the SI status imply a previous liquidity assessment. With MiFID II, the assessment of liquidity has become a crucial step, especially for fixed income instruments, as different categories (liquid vs. illiquid) will weigh significantly on the pre- and post- trade transparency requirements for these type of instruments, as well as on the application of waivers14. Systematic internalisers depend not only on the liquidity assessments, but also on the trading venues. Under Article 20(3) of MiFID II, an OTF may engage in dealing on own account other than matched-principal trading with regard to sovereign debt instruments that do not have a liquid market15. Therefore, clear instructions for determining whether a financial instrument has a liquid market are necessary. In a case study16 presented at the ECB Bond Market Contact Group, the head of the Euro Government and SSA Trading from Citi, Zoeb Sachee, exposed some comprehensive schemes with the pre- and post-trade transparency requirements depending on the type of trading mechanism (multilateral or bilateral) and the conditions fulfilled.

14 Idem. 3 15 European Securities and Markets Authority (ESMA) (31 January 2017), Questions and Answers on MiFID II and MiFIR market structures topics, p. 36 16 Sachee, Z. (2015), MiFID II pre- and post-trade transparency - Impact on bond markets, ECB Bond Market Contact Group

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What we observe is that, in all cases, the verdict of being liquid attracts a series of obligations regarding the quoting regime. In the pre-trade stage, bilateral trading seems to get more affected than the multilateral side for one important reason: SIs will have to provide their customers with firm quotes, meaning that any of their clients can hit them anytime. Also, indicative quotes will have to be made public by SIs, thus amplifying the hostile regime conditions. In order for clients to remain confident in the SIs, indicative pricing should represent a realistic image of the way the market player is actually willing to execute its transactions. Therefore, judging by the pre-trade transparency requirements, the new Regulation appears to tend towards encouraging more venue trading than bilateral transactions.

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On 28 September 2015, ESMA submitted draft RTS to specify transparency requirements for trading venues and investment firms in respect of bonds, structured finance products, emission allowances and derivatives as draft RTS 2 to the European Commission (the Commission) pursuant to Article 15(1) of Regulation (EU) 1095/2010 (ESMA Regulation) and Articles 1(8), 9(5), 11(4), 21(5) and 22(4) of MIFIR. For those fixed income instruments that are not liquid, competent authorities can waive the obligation to public pre-trade information away from market operators and investment firms operating a trading venue. Initially, ESMA proposed three quantitative criteria to assess liquidity on bond markets: 1. Average daily notional amount traded >= €100,000 2. Average daily number of trades >= 2 3. Percentage of days traded over the period considered >= 80% While the European Commission largely agrees with the aforementioned criteria published in the Regulatory Technical Standards (RTS) 2 draft submitted by ESMA, it does request a more cautious approach before diagnosing whether a bond is liquid or not. More precisely, it questions the criterion of 2 trades per day, stating that it might not reflect the condition of ready and willing buyers and sellers on a continuous basis. ESMA considers that this criterion might raise concerns only taken on an individual basis, and this is why three cumulative conditions should be met in order to assess the liquidity of a bond. While considering the average daily number of trades condition alone might

Central Bank Journal of Law and Finance, No. 1/2017 93 The Impact of MiFID II on the Liquidity of Fixed Income Instruments capture fixed income instruments with only episodic liquidity, adding it to more than 80% of trading days is aimed at avoiding misclassifications17. Therefore, from ESMA's point of view, the concept of prevalence of ready and willing buyers and sellers on a continuous basis is best captured when using the cumulative approach. It is clear that bonds require a special treatment in terms of liquidity tests, perhaps more than any other financial instrument. Due to their complexity, the liquidity assessment for fixed income instruments will be performed per ISIN, or using an Instrument By Instrument Approach (IBIA). On the other side, most derivatives will be approached by class (COFIA). The assessment suggested by ESMA is aimed at catching the changes in market liquidity with only a short time lag. The IBIA analysis performed on a quarterly basis will, therefore, allow for a proper observation and management of the liquidity assessment process. Draft RTS 2 enhanced by ESMA should therefore provide an answer to whether the pre- trade transparency conditions imposed by MiFID II could have a negative impact on the liquidity of fixed income instruments. On a background of decreased activity in one ISIN or in a class of bonds, the instruments in case will most probably not fulfil the liquidity criteria, and, as a result, they will be waived from the pre-trade transparency requirements. The phase-in period proposed by the European Commission is intended to last four years and implies the use of a declining schedule of daily trade:

Figure 3: Phase-in Period based on the Average Daily Number of Trades Criterion As we can observe from Tables 2 and 3, the phased-in approach only regards the average daily number of trades criterion, as the thresholds for the other two remain the same across the period. By using transaction reporting data from 1 June 2013 to 31 May 2014, ESMA made a summary of the expected coverage ratio during the phase-in period, allowing the average daily number of trades criterion to take values from 15 to 2 on a decreasing basis, but maintaining the other two liquidity conditions unchanged, namely the average daily notional amount and the percentage of days traded over the period considered.

17 European Securities and Markets Authority (ESMA) (02 May 2016), Draft Regulatory Standards on transparency requirements in respect of bonds, structured finance products, emission allowances and derivatives under MiFIR, pp. 5-14

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Table 2: Number of Liquid Bonds under a Decreasing Schedule of Average Daily Number of Trades

Source: ESMA Regulatory Technical Standards 2, page 11

Table 3: Percentage of Bonds (ISINS) and Percentage of Trades Under a Decreasing Schedule of Average Daily Number of Trades

Source: ESMA Regulatory Technical Standards 2, page 12

If the coverage ratio associated with the average daily number of 15 trades/day is of about 1,100 ISINs out of a total sample of 54,395 ISINs (so a percentage of 2%), when getting to 2 trades/day it reaches 2600 ISINs, representing 5% of the total sample of fixed income instruments. Regarding the coverage ratio for liquid instruments, it is expected to increase from around 79% in the first stage of the phased-in approach to nearly 88% once the aforementioned criterion equals 2. Another important aspect that can be captured from Tables 2 and 3 is that the most affected instruments by the phase-in would be the corporate bonds, covered bonds and other public debt instruments, while the coverage ratio for sovereign bonds would be more stable; this observation is valid in terms of both percentage of trades in liquid instruments and percentage of liquid ISINs.

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One problem arising from the data used is that they come from transaction reporting, which is not a tool for statistical analysis but an instrument designed to serve market integrity. Although the transaction reporting data are aimed at providing an accurate image of trading in the Union, it is still not a flawless data source. Stakeholders even warn that transaction reporting based on post-allocated trade data could lead to the underestimation of the actual size of trades and the overestimation of the number of trades. Given the uncertainty of the impact of the transparency regime on bond trading and the impossibility of holding 100% reliable data, ESMA recognizes the importance of a phased- in implementation.

Table 4: Trax IBIA Calibration with Phase-in Based on 2015 DATA

Source: ESMA Regulatory Technical Standards 2, page 12

The effects of the phased-in approach will also be seen on the newly issued bonds. Under ESMA, the liquidity status of these instruments will be initially determined by using COFIA (Classes of Financial Instruments Approach). Hence, papers above a specific issuance size would be declared as liquid until the first quarterly liquidity assessment. As we can see from Fig. 1, using IBIA results in a significantly smaller coverage ratio for corporate and covered bonds in the initial stages of the phased-in implementation. On the other hand, the first liquidity assessment for the same type of newly issued instruments will be subject to the same issuance size during the lifespan of the phase-in. In order to avoid a cliff effect where most newly issued covered and corporate papers – initially

96 Central Bank Journal of Law and Finance, No. 1/2017 Andreea Oprea declared liquid – would change their liquidity status at the first IBIA assessment, ESMA came with some proposals of calibration: First, the issuance size used in the first liquidity assessment was calibrated to fit the liquidity criterion of an "average number of daily trades" of at least 2, used in IBIA. The logic behind this adjustment was that the issuance of a bond was positively correlated to its average trading frequency and hence to the liquidity of the bond. We will explain the relationship between the issuance size of a bond and its liquidity on the secondary market later on in this article. ESMA suggested raising the threshold for newly issued corporate and covered bonds, during the first two stages of the phased-in implementation, from EUR 500 million to EUR 1 billion; the first liquidity assessment for papers issued until 31 December 2019 will, therefore, use the issuance size of EUR 500 million, while those issued thereafter will be subject to the EUR 1 billion threshold. In a letter forwarded to ESMA on the 14th of March 2016, The Department for Financial Stability and Capital Markets, in charge of the banking and finance policies of the European Commission (DG FISMA), proposed the former that an annual liquidity assessment should be performed prior to each move to a subsequent daily trading threshold. DG FISMA suggested that the annual evaluation should fulfill the following conditions: 1. The number of ISINs classified as liquid corresponds to the coverage estimations made by ESMA with data from the transaction reporting: 1100 ISINs in the first year, 1500 and 2600 ISINs in the second and third year respectively. 2. The annual trading volume for each paper that is subject to pre-trade transparency does not decline after moving to a lower threshold in the average daily number of trades. 3. The annual number of transactions for the specified fixed income instruments does not decline after moving to a lower threshold. Although ESMA recognizes the importance of monitoring and controlling the effects that the transparency requirements have on the bond market, it does doubt the feasibility of the predefined criteria proposed by DG FISMA. ESMA argues that although they are quantifiable, they are backward-looking, and therefore do not take into account the possible effects that new thresholds would have on bonds' liquidity; in turn, the aforementioned criteria would only represent an instrument in the analysis of a sheer historical causality. It is true that historical data often serve as a proxy in the determination of future relationships, but in this case ESMA opines that a decline in one of those criteria may be triggered by a multitude of other factors that are not linked to the MiFIR transparency requirements, ranging from changes in general liquidity conditions, in monetary policy, in behaviour of market participants to changes in market structures and that under the proposed approach ESMA cannot compensate for the effect of those external factors, which may result in a distorted assessment18.

18 European Securities and Markets Authority (ESMA) (02 May 2016), Draft Regulatory Standards on

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In conclusion, the liquidity assessment of Liquid for fixed income instruments is based on a periodic (quarterly) assessment of quantitative liquidity criteria on an Instrument by Instrument approach (IBIA) and it requires the cumulated fulfilment of 3 conditions:

Average daily notional Average daily number of Percentage of days traded over amount trades the period considered [quantitative liquidity [quantitative liquidity [quantitative liquid criteria 3] criteria 1] criteria 2] EUR 100,000 S1 S2 S3 S4 80% 15 10 7 2 Source: Amended draft Regulatory Technical Standards on transparency requirements in respect of bonds, structured finance products, emission allowances and derivatives under MiFIR, 2 May 2016, ESMA/2016/666 p. 39

While The Average Daily Notional and Average Daily Number of Trades appear like low hurdles for many bond issues, the Percentage of Days Traded at 80% will exclude many issues. As a side note, ESMA collected bond transaction data for the period Jun 2013 to May 2014 and included in the analysis 54,935 bonds, out of which 49% did not trade over the period, so there are tens of thousands of ISINs, out of which a decent portion should be liquid. Bonds that are admitted to trading or first traded on a trading venue in the prior quarter shall be considered to have a liquid market based on the Issuance size table from Appendix 2 (Table 5). From Table 5, we can also see that a Sovereign Bond with Issue size of €1billion or more will be considered as Liquid, while a Corporate Bond with Issue size of €500million or more will also be Liquid. Bonds first traded in the period from Oct 1, 2016 to Jan 3, 2017 shall be considered not to have a liquid market.

5. CONCLUSIONS

Unlike other financial instruments such as equities -that are fairly homogenized and easy to trade- fixed income products come in many different shapes and sizes. Bonds have been traded mainly via quote-driven OTC bilateral systems, given the diversity of issuances, structures, credit qualities and maturities, which makes them extremely challenging to match in buy and sell orders, especially at the same size and price. The complexity of bonds makes them not only resistant to the current advances in technology, as trading machines still remain behind human bond traders, but also very sensitive to

transparency requirements in respect of bonds, structured finance products, emission allowances and derivatives under MiFIR, pp. 5-14

98 Central Bank Journal of Law and Finance, No. 1/2017 Andreea Oprea the changes generated by the latest financial markets regulations, like MiFID II. The improvement that MiFID II is expected to have on pre- and post-trade transparency comes with a cost, as most traders believe the regulation will negatively impact the liquidity on the bond markets. The verdict of being liquid under the criteria proposed by ESMA will attract a series of obligations for fixed income dealers regarding the quoting regime. In the pre-trade stage, bilateral trading appears to be more affected than the multilateral side for one important reason: Systematic Internalisers will have to provide firm quotes to their customers, meaning that they should be ready to trade that specific instrument for which they fulfil the SI criteria at any time. Moreover, indicative quotes will have to be made public by SIs, thus amplifying the hostile regime conditions. Indicative pricing is not a refuge for traders, as it should represent a realistic image of the way a market player is actually willing to execute its transactions, so that clients remain confident in it. Therefore, if we were to judge in terms of pre-trade transparency requirements, MiFID II seems to lean towards encouraging more venue trading than bilateral transactions. Again, this could translate into though times for fixed income markets, which until now have accounted pretty much on human interactions. Some specialists from Bloomberg opine that the more money that’s at stake, the more human interactions count, that these interactions have the role of bringing market colour and generating liquidity for those blocks that are hard-to-trade. In addition, they affirm that no robot has been invented yet that can truly understand the finesse of price discovery needed by traders. We tried to provide an analysis of the impact that MiFID II would have on the liquidity bond markets especially from a dealer’s perspective. Some specialists from Citi Markets dug deeper into the problem and spotted some potential shortcomings of the regulation. For example, with respect to the liquidity thresholds, there is an increased risk that a large number of illiquid bonds would be incorrectly classified as liquid (“false positives”). This, in turn, will lead to a severe discouragement of liquidity provision in those illiquid instruments, which will determine dealers to demand extra compensation when quoting. Ultimately, this will translate into a higher cost for clients. Regarding the liquidity assessment approaches, unlike COFIA (Classes of Financial Instruments Approach), IBIA (Instrument by Instrument Approach) has the advantage of being more precise and easier to implement with an appropriate operational structure. This aspect comes as a positive fact since the latest RTS (Regulatory Technical Standards) define liquid bonds at an instrument/ISIN level. Besides liquidity, other threats identified by dealers relate to the reliability of data quality, international inconsistency (there is no pre-trade anywhere else globally in fixed income), SI discrimination, price differentiation, implementation costs or unpredictable behaviours through intervention policies such as QE (Quantitative Easing).

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In respect of trading venues, the extent to which investment firms will prefer to operate OTFs (Organized Trading Facilities) instead of MTFs (Multilateral Trading Facilities) for trading fixed income instruments remains to be seen. OTFs benefit from the opportunity to apply discretion, which might be appealing up to some point. However, unlike MTFs, they will have to comply with more investor protection obligations related to information provided to clients, suitability tests, best execution practices and client order handling. Given the regulatory burden, investment firms might also decide upon reconfiguring their platforms to make them non-discretionary, rather than having to comply with so many additional investor protection rules. In this article we gave the example of Article 24 from the Regulation, which requires investment firms to act honestly, fairly and professionally in accordance with the best interests of its client, for all information addressed to clients to be fair, clear and not misleading, and all costs and charges to be aggregated to allow the client to understand the overall cost as well as the cumulative effect on return of the investment. We concluded that all this might sound a little bit too much for the well- functioning of a business, as a large amount of time resources would be directed to provide clients with full dissemination of information. Furthermore, regarding the dissemination of information, we agreed upon a statement given by Per Loven, the commercial director from TRADEcho, saying that transparency is necessary […] but transparency just for the sake of transparency itself does not necessarily bring any gains. He also emphasised the difference of approaches between retail and institutional investors, in the sense that while pricing disclosure might be important for the former, for the latter, the depth to liquidity is more important; and since flows on the bond markets are largely driven by Institutional players, then more questions arise: whose interest should be served first and to what extent is pricing disclosure beneficial? What seems to be clear until now is that opinions regarding the future of the bond market in the new MiFID II era come in two forms: first, there are the pessimistic ones, who believe the implementation of MiFID II’s pre-trade transparency requirements will only serve to make an already challenging corner of the bonds market even more challenging; they are the ones who consider that a delay in the implementation of MiFID II or, at best, the revision of the Regulation by reneging on the pre-trade transparency proposals for fixed income trading are the solutions to keep this market alive; on the other side of the table, the more optimistic ones consider that MiFID II might even boost bond liquidity. For example, the chief executive of TwentyFour Asset Management, Mark Holman, declared that the increased transparency would give bond investors more confidence in market conditions. Overall, we consider the truth must be somewhere in between, as, for instance, the optimal level of transparency remains unknown and there are not few specialists who argue that too much transparency would kill liquidity. However, it is also true that the rules on reporting transparency might be phased in slowly. Regarding this

100 Central Bank Journal of Law and Finance, No. 1/2017 Andreea Oprea particular aspect of the implementation and the liquidity assessment issue that we have previously addressed in this article, Tim Cant, a counsel in Ashurst’s financial regulation practice, affirms that the revised calculations for when and where a bond [for example] is liquid or illiquid will likely mean that in the first two years post-Mifid II much of the market is permitted to waive pre-trade transparency and therefore the impact on price formation will be reduced.

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APPENDIX 1. LIQUIDITY ASSESSMENT FOR BONDS BASED ON ISSUANCE SIZE

Asset class - Bonds (all bond types except ETCs and ETNs) Each individual bond shall be determined not to have a liquid market as per Article13(18) if it is characterised by a specific combination of bond type and issuance size as specified in each row of the table

Issuance Size Bond Type (smaller than €) Sovereign means a bond issued by a sovereign issuer which is 1 billion Bond either: (a) the Union; (b) a Member State including a government department, an agency or a special purpose vehicle of a Member State; (c) a sovereign entity which is not listed under points (a) and (b). Other Public means a bond issued by any of the following public 500 millions Bond issuers: (a) in the case of a federal Member State, a member of that federation; (b) a special purpose vehicle for several Member States; (c) an international financial institution established by two or more Member States which have the purpose of mobilising funding and providing financial assistance to the benefit of its members that are experiencing or are threatened by severe financial problems; Convertible means an instrument consisting of a bond or a 500 millions Bond securitised debt instrument with an embedded derivative, such as an option to buy the underlying equity Covered Bond means bonds as referred to in Article 52(4) of 500 millions Directive 2009/65/EC Corporate means a bond that is issued by a Societas Europaea Bond established in accordance with Directive 2001/2157/EC or a type of company listed in Article 1 of Directive 2009/101/EC or equivalent in third countries Bond Type For the purpose of the determination of the financial instruments considered not to have a liquid market as per Article 13(18), the following methodology shall be applied Other Bond A bond that does not belong to any of the above bond types is considered not to have a liquid market

Source: Regulatory Technical and Implementing Standards – Annex I MiFID II/MiFIR, 28 September 2015, p.77

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REFERENCES

1. Bernard, C. (2014), MiFID II: The new market structure paradigm, Linklaters, p. 3 2. ECMI-CEPS Seminar, 6 April 2017 Brussel, Unravelling Ariadne’s MiFID II Thread: Pre- and post-trade transparency, for non-equity markets 3. European Securities and Markets Authority (ESMA) (2 May 2016), Amended draft Regulatory Technical Standards on transparency requirements in respect of bonds, structured finance products, emission allowances and derivatives under MiFIR, p. 39 4. European Securities and Markets Authority (ESMA) (2 May 2016), Draft Regulatory Standards on transparency requirements in respect of bonds, structured finance products, emission allowances and derivatives under MiFIR, pp. 5-14 5. European Securities and Markets Authority (ESMA) (28 September 2015) Regulatory technical and implementing standards – Annex I MiFID II/MiFIR, p.77 6. European Securities and Markets Authority (ESMA) (31 January 2017), Questions and Answers on MiFID II and MiFIR market structures topics, p. 36 7. European Securities and Markets Authority (ESMA) (21 August 2015), Waivers from Pre-trade Transparency, CESR positions and ESMA opinions, p. 3 8. Global training, Part of University of Nicosia, MiFID II (prepared by Olivia Parpa), presented at the Romanian Institute of Financial Studies, pp. 17- 18 9. Healey, R., (July 2012), MiFID II and Fixed-Income Price Transparency: Panacea or Problem?, Tabb Group, Global Fixed Income Division, p. 18, 24-25 10. Sachee, Z. (2015), MiFID II pre- and post-trade transparency - Impact on bond markets, ECB Bond Market Contact Group Links: https://www.lseg.com/resources/mifid-ii/transparency-requirements http://www.investopedia.com/terms/c/cross.asp https://investoradvocacyclinic.wordpress.com/2014/04/01/discretionary-vs-non- discretionary https://www.financierworldwide.com/organised-trading-facilities-how-they-differ-from- mtfs/#.WeCS-q2cylg https://www.bloomberg.com/professional/blog/know-customer-get-mifid-ii-right-first- time http://ec.europa.eu/finance/securities/isd/mifid2/index_en.htm https://www.esma.europa.eu/policy-rules/mifid-ii-and-mifir 25 June 2017 https://www.clarusft.com/mifid-ii-and-transparency-for-bonds-what-you-need-to-know http://www.cityam.com/225410/eus-new-mifid-ii-rules-shake-bond-and-commodity- markets-bid-more-transparency-heres

Central Bank Journal of Law and Finance, No. 1/2017 103 The Impact of MiFID II on the Liquidity of Fixed Income Instruments https://www.bloomberg.com/professional/blog/regulation-watch-mifid-ii-transparency- regime http://www.thetradenews.com/Asset-Classes/Fixed-income/EU-experts-reviewing- MiFID-II-bond-rules,-says-Commissioner http://www.capitalmarkets-forum.com/commentary/clarifying-mifid-ii-pre-and-post- trade-transparency-waivers-corporate-bonds https://www.bonddickinson.com/insights/publications-and-briefings/mifid-2-essential- checklist http://www.thetradenews.com/Asset-Classes/Fixed-income/EC-overrules-ESMA-on- finalised-MiFID-II-bond-rules https://blogs.cfainstitute.org/marketintegrity/2015/10/15/esma-sets-mifid-ii-rules- complex-balance-between-transparency-and-liquidity http://www.nortonrosefulbright.com/knowledge/publications/132771/10-things-you- should-know-the-mifid-ii-mifir-rts https://marketsmedia.com/mifid-ii-systematic-internalisers-raise-concerns/ https://www.fnlondon.com/articles/banks-hopeful-of-reprieve-on-mifid-bond-rules- 20160422 https://www.marketaxess.com/research/blog/single.php?permalink=will%20MiFID%20 II%20accurately%20classify%20liquid%20and%20illiquid%20bonds#.WU-G5ZLyjIU http://www.bestexecution.net/fixed-income-trading-focus-future-bond-market-russell- dinnage https://www.perfectchannel.com/blog/the-impact-of-mifid-iis-regulatory-framework- on-the-otc-markets https://www.ftadviser.com/Articles/2017/06/09/IA-p3-120617-Package-1-Mifid- liquidity

104 Central Bank Journal of Law and Finance, No. 1/2017 Two Currencies - Two Destinies: The Romanian Leu - The Moldovan Leu

Alexandru M. Tănase*

Abstract

The objective of this paper is to present the two currencies with a common name of two neighbouring countries with intertwined destinies. History was not very kind to Romania and/or to the Republic of Moldova (Moldova in this paper). The different evolutions of their currencies are just a reflection of the two tumultuous destinies. Romania has a long recorded history and so does the Republic of Moldova, but Romania has been a NATO country since March 2004, with a full European Union membership since 1 January 2007. Meanwhile Moldova is still at the crossroads. Nevertheless, one could easily realize that the two countries have much more in common than the name of their respective currencies. Their neighbouring relations are much more complex, much deeper and have a unique fabric. Their respective currencies’ evolution, which this paper tries to unveil, is only part of this fabric.

Keywords: Currencies, Romanian Leu, Moldovan Leu, National Bank of Romania (NBR), National Bank of Moldova (NBM), IMF, EBRD, national currency history

JEL Classification: E40, E42

* Independent Consultant and Former Associate Director, Senior Banker at EBRD and former IMF Advisor. He graduated as an economist from the Academy of Economic Studies, Bucharest with the first diploma in accounting and finance and the second one in international economic relations. He also holds a doctoral degree awarded by the same Academy of Economic Studies in 1997. In Romania, he started his career in foreign trade and then he worked for 10 years with the Ministry of Finance. He then worked with the IMF and EBRD. These represent the author’s personal views ([email protected]). The assessments and views expressed are not those of the EBRD and/or IMF and/or NBR and/or NBM and/or indeed of any other institution quoted. The assessment and data are based on information as of end-May 2017.

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1. INTRODUCTION

The intrinsic link between people’s lives and money goes back many centuries into mankind’s evolution. Nowadays, more and more people think that everything is about money. As Oscar Wilde put it: “When I was young I thought that money was the most important thing in life; now that I am old I know that it is”1. There is some truth in this. Every country endeavours to have its own currency as a sign of identity, sovereignty and finally of well-being. Romania and the Republic of Moldova (Moldova in this paper) are no exceptions. What is particular in the case of these two countries is that the name of their respective currencies (the Romanian Leu and the Moldovan Leu) is a common one reflecting their intertwined history. However, despite a joint name, each of the two currencies mentioned above has its own history. They could not be more different and this paper tries to explain why. This paper is part of a larger search to understand why the evolution of the two currencies was so convoluted and so different at the same time. This paper is structured in three main parts. The first one deals with the history of the Romanian Leu from its introduction in 1867 to date, while the second part attempts to describe the key milestones in the evolution of a relatively “young” currency, namely the Moldovan Leu put in circulation in 1993. The last part of the paper ventures into the risky territories of comparing the two currencies, with a parallel of their tumultuous journeys in the last quarter of a century. The economic and monetary developments of Romania and Moldova are presented in summary to facilitate the understanding of their respective currency’s destiny. Short conclusions are also presented, but the paper should be scrutinized in its entirety.

2. THE ROMANIAN LEU

2.1. The Beginnings - A Short Summary of the Convoluted History This year, Romania celebrates 150 years from the first circulation of its own currency. Back in history, the current Romanian geographic space had many currencies in circulation, most of them issued by foreign countries. Before the union of the two provinces (Wallachia and Moldova) in 1859, a monetary chaos had prevailed. Romania issued its first proper currency (the Romanian Leu) for the first time back in 1867. Based on the law published in 'Monitorul Oficial' no. 89 dated 4 May 1867, the new decimal system was inspired by the French, Italian, Belgian and Swiss models (actually, at that time, the four countries had joint monetary standards, under the auspices of the Latin Monetary Union). This was a freely convertible currency. This law provided for the issuance of the 20, 10 and 5 lei (“lei” is the plural for “leu”) made of gold, while silver coins (2 lei and 1 leu and 50 bani) and copper coins (10, 5, 2 and 1 bani/ban) were also put

106 Central Bank Journal of Law and Finance, No. 1/2017 Alexandru M. Tănase into circulation. Based on a new law issued in 1877, the Ministry of Finance issued “mortgage notes”, which were the first Romanian printed paper money. These banknotes were freely convertible in gold and silver. The National Bank of Romania (NBR) was also established in 1880. The first proper banknotes printed by Romania’s central bank are dated 19 January 1881.

Figure 1: Romania - First 20 Lei Gold Coin with the Effigy of Carol I (“Pol” in Romanian)

Source: Source: Wikipedia (http://currencies.wikia.com/wiki/Romanian_20_leu_coin - consulted on 13 February 2017)

On 24 November 1864, Casa de Depuneri şi Consemnațiuni (the Deposits and Consignments House) was established, the first credit institution of Romania and the main one of the country until the establishment of the NBR in 1880. It was later reorganized and renamed as Casa de Economii și Consemnațiuni (Savings Bank) (CEC) on 7 October 1949 and more recently (in 2008) as CEC Bank.2 For the history of the Romanian Leu, this institution played a fundamental role, especially in the early days of its existence.

An important change took place in 1890 when the Romanian monetary system was restructured and put on a mono-metallic base, with gold as a single reference point3. The Romanian Leu had been convertible up to 1914 when World War I (WWI) erupted. During WWI, all the gold and silver coins were treasured, and under severe domestic and external conditions, the banknotes became, de facto, non-convertible. Even worse, the Romanian treasure was moved to Moscow to be protected against the Germans, but it never came back (see box below). This was a heavy blow to the fate of the Romanian Leu and to the country.

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Box 1: Romania - The Case of Its National Treasure4 Romania uninspiredly decided to move its national treasure to Russia during WWI (1916-1917), but just a small part of the whole consignment has ever been returned. The original documents attesting to the transport of the Romanian (state and privately owned) treasure to Moscow are in the possession of the National Bank of Romania (NBR). A historical artefact (“Cloșca cu puii de aur”) and some historical documents were returned by the then Soviet Union authorities to Romania during communist times as a gesture of friendship. However, the Joint Russian-Romanian historical commission established in 2004 to search the fate of the Romanian treasure and gold (93.4 tonnes of pure gold, including coins made of gold and many other Romanian assets part of the national treasure/trove) has not reached any conclusion/agreement so far. One hundred years later, Romania is still deprived of its treasure estimated at a current market value of approximately USD 5 billion, with a negative impact on the Leu’s strength. In parallel and over time, Romania has built up its gold holdings again. As of end-2016, Romania has held 103.7 tonnes of pure gold (3.33 mil. ounces) which, at the then market price, was valued at EUR 3.66 billion (EUR 3.77 billion as of end-May 2017). Currently, these gold holdings are a solid anchor for the stability of the macro-economic equilibria and, at the same time, they offer the “credibility”5 required in international banking. Coming back to the historical events, there are lessons to be learnt from the fate of gold during WWI, especially by the smaller developing nations and by the transition countries situated in uncertain turbulent geo-political regions. Romania has learnt its lesson. During WWII, the newly accumulated Romanian gold was hidden in the Carpathian Mountains (Tismana Cave) which proved to be a more reliable safe keeper. This time, the treasure returned in full and safely back into the vaults of the NBR after WWII, initially in Bucharest and subsequently in other safe locations such as London. It has recently been disclosed that Romania holds approximately 60% of its total gold reserves in London for easy administration, security and guarantee for honouring its external commitments6.

Under such difficult circumstances and upon the conclusion of WWI, the circulation of the Romanian Leu was nevertheless significantly enlarged for the whole territory of what the historians called „the Greater Romania”. The monetary unification from 1920-1921 is one of the reference points in the history of the Romanian Leu. It was the depth of the changes made, the enlargement of the geographic space in which the currency circulated for the next few decades and the stable features of the Leu that were to be recorded up to

108 Central Bank Journal of Law and Finance, No. 1/2017 Alexandru M. Tănase the big crash by the end of the third decade of the twentieth century. The Leu’s stabilisation undertaken in 1929 was indeed required under the then prevailing circumstances. According to the stabilisation act, the Leu was redenominated as the equivalent of 10 milligrams of gold7. This was, in fact, a huge depreciation as compared to the gold equivalent defined in the 1867 and 1890 laws, respectively. The second short period of the Leu’s convertibility was between 1929 and 1933, known as the so-called interwar convertibility. In accordance with the stabilisation law, the new banknotes issued by the NBR in 1929 were declared as freely convertible against gold and/or other hard currencies. However, the next trend was worrisome. The foreign currency reserves of the NBR sharply declined from Lei 3.6 billion as of 9 March 1929 to Lei 80 million as of February 1932 and, therefore, the freely convertible status of the Leu was suspended. This was very bad for the Leu and Romanian exporters and the then authorities introduced the so-called foreign currency stimuli, which actually represented disguised subsidies. Also, it should be noted that the coverage of the money in circulation with gold was partially wrongly computed in those years, taking into account the gold deposited in Moscow, but the history showed just how uninspired that decision was (see Box 1).

2.2. Post War (WWII) Status Following the fate of the Romanian state and economy, the Leu was in a very difficult position by the end of World War II (WWII). During WWII, the Romanian Leu lost more than 60% of its purchasing power it had had when the war started8. The historians are still struggling to understand the reasons behind the fate of Romania in the ‘40s, but the fact is that the Romanian production did not register a positive trend. The state needed huge amounts of money to finance its increasing military expenditures. This was one of the reasons why the NBR was “forced” to issue more and more currency without any correlation with the quantities of goods in the country. The data published by the NBR are more than significant: a) from 1938 up to 1941, the monetary base increased from Lei 29.4 billion to approximately Lei 70 billion (to be noted that, by the end of this period of time, Romania lost a part of its territories, which made this increase even bigger, relatively speaking); and b) from 1941 to 1945 the monetary base continued to increase at an alarming pace from Lei 77 billion to Lei 649 billion. Under such circumstances, the Romanian Leu suffered the largest losses of substance, in accordance with the data published by the Bank for International Settlements (BIS) - Basel. The 1947 monetary stabilisation was done at the time when the highest level of inflation was registered. By this time, the Leu had lost any trust of the population whatsoever. New and repeated issues of banknotes with larger and larger denomination (see Table 1) had a single effect, namely to confirm what the population already knew: the issuance of banknotes with large (or larger and larger) denomination is a clear sign that the currency is in big trouble. One could easily draw a parallel between this period and the 1995-1996 trends. There were striking similarities between the Leu’s evolution during 1995-1996 and the one just before the stabilisation from 1947.

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Table 1: Romania - Coins and Banknotes Issued, 1946 - 1947

Year Value Metal/Issue Quantities Numbers Coins 1946 500 Lei Aluminum 5,823,000 1946 2,000 Lei Copper-Zinc-Nickel 24,619,000 1946 25,000 Lei Silver 2,372,600 1946 100,000 Lei Silver 2,002,000 1947 10,000 Lei Copper-Zinc-Nickel 11,850,000 Banknotes 1946 100,000 Lei 1 April 1946 - 28 May 1946 21 October 1946 20 December 1946 1947 100,000 Lei 8 May 1947 - 25 January 1947 1947 1,000,000 Lei 16 April 1947 - 1947 5,000,000 Lei 25 June 1947 - (two distinct issues) Source: Prepared after data published by I. Dogaru - Emisiuni de monede și bancnote românești, București, 1984, pages 22, 23 and 63 (Romanian language)

By the end of the war (WWII), the Romanian economy was again in a very difficult position. Despite heroically fighting together with the allied armies after 23 August 1944, Romania was treated as a defeated country when peace was concluded and it had to pay huge damages to the Soviet Union. This had a very negative impact on the fate of the Leu9. Apart from the huge material and human losses, Romania was hit by one of its most severe droughts in the late ‘40s. High inflation eventually led to a large depreciation of the currency. This is the period when banknotes of Lei 1,000,000 were printed and circulated. This led inevitably to the monetary stabilisation in 194710, followed soon (in 1952) by the second stabilization of the currency. In both cases, the currency was not simply replaced. The then Romanian authorities aimed for more. They wanted to redistribute the wealth of the society by regulating the quantity of money held by various categories of population. The more affluent people were strongly hit. The amounts of old currency that was allowed to be changed were strictly regulated in 1947 and even more so in 1952. Moreover, in 1952 the state used different exchange rates in changing old against

110 Central Bank Journal of Law and Finance, No. 1/2017 Alexandru M. Tănase new currency. Basically, those people having large amounts of cash were unable to change them for the newly introduced monetary signs. Also, the social changes marked by the nationalisation of all productive assets on 11 June 1948 did not help to improve the Leu’s status. In a retroactive analysis, one could say that these two stabilisations managed what they were intended to, namely the creation of the basic conditions for socialist methods to be implemented in the country. For instance, the money in circulation was dramatically reduced from old Lei 48,451 billion as of 14 August 1947 to only new Lei 1,377.6 million on 15 August 1947. Irrespective of its economic and political impact, the two monetary stabilisations strongly diminished the trust of the population in the currency. This psychological impact was so strong that it reverberated even during Romania’s transition to a market economy, more than half a century later. The entire period which followed the two stabilizations in 1947 and 1952 is just a mere reflection of a theory with much larger implications. The Leu’s destiny closely followed that of the Romanian economy.

2.3. 1970 - 1989 Developments For the evolution of Romania and its Leu in those days, one particular decade (1970 - 1980) is worth investigating. To the surprise of the international community, the Romanian authorities decided to join the International Monetary Fund (IMF) and the World Bank. The IMF Charter was signed by Romania on 15 December 1972 and Romania paid its quota in hard currencies and partially in gold (like all other members). This was a bold achievement, especially more so that Romania was the second socialist country to join the IMF (after Yugoslavia - a founding member)11. Romania’s membership in such prestigious international financial institutions (IFIs) offered the Romanian Leu a strong financial support in enforcing its status of a trustworthy currency. Technical assistance was granted to Romania by both institutions. However, during this decade, Romania introduced the “internal coefficient for settlement” (originally “coeficientul intern de calcul” (CIC) and later “coeficientul intern de decontare” or (CID)) for its external transactions. This represented, in fact, a way to adjust the official exchange rate of the Leu (which was overvalued or sometimes extremely overvalued) closer to the actual value of the goods exported or imported by Romania. A very complex system of currency adjustments started to be run by the Ministry of Finance. These currency adjustments were, in fact, subsidies for exporters and taxes for importers. Apart from the interventionist role of the state, a more negative impact should be noted, namely that the internal production prices and finally the consumer prices (together “domestic prices”) were distorted. This could be seen as a minor negative impact, but it was a material distortion of the competitive advantage of the Romanian economy versus its partners on the international markets. It is safe to state that Romania did not have a proper instrument of measuring the efficiency of its external transactions. Despite all these setbacks, in 1974 the authorities declared the introduction of the Leu’s convertibility as a major objective of their economic policy. This objective

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(like many others) has never been achieved. Simply put, Romania did not meet the required conditions to introduce the convertibility of its currency back then. The approval and the implementation of Law No. 12/1980 on the settlement of the foreign currency achieved or required for foreign trade transactions or for economic international cooperation brought in a change in the processing of foreign transactions of Romania. Any such external transactions were processed based on “a unique commercial exchange rate” (“cursul comercial unic” (CCU))12. The official exchange rate of the Leu was abolished. After only a few years of implementation, the CCU would also depart from its real value. The following CCU levels were established in an administrative manner, based on decrees, and soon the Leu would start a very convoluted trend. The political will of the Romanian authorities was behind all these rather than the fundamental economics. Sooner than later, the old system of foreign exchange subsidies appeared again and the interventionist role of the state was a distinct feature up to end-1989. To be noted that these subsidies were, in fact, “planned” by the Ministry of Finance, Ministry of Foreign Trade and International Economic Cooperation, State Planning Committee13 and by each economic ministry for its sector. These subsidies were never accepted as sound economic and banking practices by the representatives of the international financial institutions, especially by the IMF. Those days, the prevailing advice from the IMF was that subsiding exports and/or taxation of imports should have been done in a very transparent way, not via an obviously overvalued CCU of the Romanian Leu. Moreover, in their desire to hide the actual facts, the Romanian authorities used to present the IMF with a centralised state budget which did not include these subsidies. This was one of the reasons for which macro-economic disequilibria started to appear and to gain significance. The computation of the National Income (old socialist methodology and terminology) and of the Gross Domestic Product made by the IMF, based on the data provided by the Romanian authorities, had a distinct item called “Errors and Omissions”. This item was much larger in Romania’s case as compared to other former socialist countries. The Leu’s exchange rate, artificially kept at the level of 15 - 18 lei/USD, had a negative impact on the measurement of the efficiency of foreign trade and service transactions. Without an adequate “meter”, the investment process was significantly distorted and the fate of the currency was just a mere reflection of those convoluted times. The careful study of this period from the Leu’s history, conducted by analysts, economists, historians, commercial traders, bankers (amongst which or starting with the current staff of the NBR) etc. would result in lessons learnt and proper economic measures for the times ahead.

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2.4. The Romanian Leu during the Transition Process

Soon after the December 1989 events, the new Romanian authorities introduced very bold measures regarding the foreign exchange regime aiming for the Leu’s convertibility. First of all, the very restrictive foreign exchange regime was relaxed during the last days of 1989. The restrictions regarding the holding of foreign currencies were abolished during the December 1989 revolution. Also, on 1 February 1990, the commercial and non- commercial exchange rates were unified at 21.00 lei/USD (from 8.74 lei/USD for non- commercial exchange rate and 14.23 lei/USD for the commercial one, as historically recorded as of end-January 1990). Nevertheless, the level of 21.00 lei/USD was not the equilibrium exchange rate for the Leu. It was an important step, but not a sufficient one. As of 1 November 1990, a new depreciation of the Leu took place, at a higher level, of 35 lei/USD. At the same time, the first phase of price liberalisation started. As of 1 April 1991, the second phase of price liberalisation started and a new depreciation followed suit. A very bold depreciation of the currency to 60 lei/USD was the eventual result. The privatisation process started in parallel in August 1991 and the banking sector was restructured. The first inter-banking market was also organised in Bucharest in August 1991, after decades of central planning. The Leu’s exchange rate was quoted on a daily basis since then and the level of 200 lei/USD was soon reached. Those dramatic days of the Romanian Leu were the clear reflection of the sharp economic decline registered then by the economy. But more was to come! Under the circumstances, the Leu started to have parallel exchange rates again. A new attempt to unify the “grey” market exchange rates with the one quoted in the interbank market was made on 11 November 1991. The new unified level was equal to 180 lei/USD. An “internal convertibility” (or more precisely “a partial current account convertibility”) status was granted to the Leu. However, a new mechanism of handling the foreign currency was introduced. In fact, all economic agents were forced to surrender their foreign currency incomes to the banks. According to the data published by the NBR, this mechanism had “positive effects only during its first two months”14. Besides this period, the Leu’s exchange rate was frequently “frozen” or, in more precise terms, it was “manipulated” (for instance, at the level of 198 lei/USD up to March 1992, then again at the level of 226 lei/USD up to May 1992 and finally at the level of 430 lei/USD during the last quarter of the same year). If the level of inflation from those days is taken into account, it is quite clear that, during these periods of time, the Leu was over-appreciating in real terms. The gap between the nominal exchange rate and the effective one started to widen and the trust of the population in the Leu sharply declined. The run after USD had already started. The “dollarization” of the economy became a common and almost continuous feature. Looking back, this could be considered one of the most difficult periods in the Leu’s destiny, but its future evolution would offer even more surprises. The year of 1993 was also a difficult one for the Leu. As of the beginning of the year, the Leu had been quoted at 432.86 lei/USD, but by December 1993 it already reached 1,276 lei/USD. The paradox consisted in the fact that, while the Leu depreciated more than

Central Bank Journal of Law and Finance, No. 1/2017 113 Two Currencies - Two Destinies. The Romanian Leu - The Moldovan Leu double in nominal terms, the gap versus the quotations made by the “foreign exchange houses” and by the “black market” or by the “grey market” (at 1,700 - 1,800 lei/USD) continued to increase. This time, the Leu’s history was more or less similar, namely “freezing” periods were alternated with periods of large volatilities. In August 1994, the NBR authorised the commercial banks to publish their own quotations for the Leu. The official rate was supposed to be a mere average of those quotations. “Freedom” had been in place until 1996 when the NBR interfered again. The dealer licences of most commercial banks were withdrawn (in March 1996 only four banks were allowed to quote the Leu). The international markets reacted in a very negative way and the IMF suspended disbursements under the existing agreements. Moreover, in June 1996, the Romanian authorities decided to ask 112 companies to surrender their foreign currency obtained from exports of oil products, wheat, wood and edible oil15. This was justified by the need for foreign currency for energy imports for the coming winter. Once again the IMF put pressure on the Romanian authorities to abolish or reduce the list to only 12 companies, but this type of actions did not support the stability of the Leu. In September 1996, the Leu’s exchange rate was “frozen” again and large gaps started to appear between the official exchange rate and the rates from exchange bureaus (up to 25% in November 1996). These actions diminished the trust of the population and of the international markets in the Leu. Its dramatic evolution up to re-denomination is presented in Table 2. Table 2: Romania - Exchange Rate for Leu, 1989 - 2004 Year (end of) Lei/USD 1989 14.44 1990 34.71 1991 189 1992 460 1993 1,276 1994 1,767 1995 2,578 1996 4,035 1997 8,015 1998 10,951 1999 18,255 2000 25,926 2001 31,597 2002 33,500 2003 32,595 2004 29,100

Source: IMF - International Financial Statistics (various editions), EBRD Transitions Reports (various editions) and NBR’s data.

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2.5. More Recent Developments. 2005 Re-Denomination The level of the Leu’s exchange rate reached in the first years of the 21st century was not sustainable from many points of view. The accounting systems were clogged with very large numbers (almost impossible to administer with the IT technology available in those days), the cash in circulation was very difficult to handle and, more importantly, the trust of the population in a weaker and weaker Leu (printed in banknotes with larger and larger denominations - up to Lei 1,000,000) was running out. Under such circumstances, on 1 July 2005, the NBR took the right decision to re-denominate the old Romanian Leu (ROL) (see below in Figure 2) and to print a new currency, the new Romanian Leu (RON), in what was called by historians a new monetary reform (10,000 old Romanian lei (ROL) were changed for 1 (one) new Romanian Leu (RON)). The newly re-denominated Romanian Leu is also presented in Figure 2. A monetary stabilisation was not the intention of the Romanian authorities as there were no restrictions (like in 1947 and 1949) on the amount of old currency allowed to be changed. In fact, the old currency was still in circulation in parallel and permission was given to change it against the new currency during a period of 6 months. It is fair to say that NBR’s action facilitated very much the Romanian accounting system and the relevant statistics. It also facilitated the use of Automatic Teller Machines (ATMs), as the sizes of the newly printed banknotes were very similar to those of the common European currency (EUR). Also, the re- denomination was presented as a step in the right direction in view of Romania’s declared goal to adopt the EUR16 (but one should note that the goalpost for this historic achievement was moved many times due to both international events related to the European Union or EUR itself and to Romania’s own internal issues). However, from a cultural point of view, in many places (especially in the flea markets), Romanians still speak about prices denominated in ROL. This very confusing situation (especially for tourists, mainly foreigners) just demonstrates the material and emotional bearing of the currency (the Leu in this case) on the population’s way of thinking and behaving.

Figure 2: Romania - The Old and the New Romanian Leu Introduced on 1 July 2005

Source: NBR Website/Numismatics. See also Note 8.

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Over the last 12 years, the Leu has continued to fluctuate and to follow what could easily be called a tumultuous evolution of the Romanian economy. On top of this, the severe international banking crisis of October 2008 left a heavy mark on the Leu. Graph 1 below is a simple illustration of this evolution to end-2016 when the Leu was quoted by the NBR at 4.50 lei/EUR. And, most likely, the story is not over.

Figure 3: Romania – Leu's Exchange Rates vs. EUR and USD, 2005-2016

Source: Compiled based on data published by the NBR (Interactive Data Base)

2.6. Interest Rates during the Transition to a Market Economy Generally speaking, the central banks of many countries, and even more so, the central banks of the transition countries have a few instruments at their disposal, through which they can influence the destinies of their currencies. Amongst these, the fixing of the interest rates is a pure attribution of central banks, apart from controlling the quantity of money in circulation, regulating the minimum reserves requirements of the commercial banks, deciding the issuing of bonds and their key terms and conditions, and other monetary instruments. In transition economies, the “interest rate” instrument started to be effectively utilised at the beginning of the ‘90s, after years and years in which interest rates only played a passive role in the stimulation of production and trade. However, back in those days, the dynamics of the interest rates were very “erratic”, to say the least. Refinancing rates reached in some cases impressive levels (see Table 4 below). If interest rates are seen as “the price of money”, it should be clearly stated that rates should be positive in real terms, namely that they should be sufficient to cover the level of inflation in the respective country. Otherwise, the currency loses its purchasing power, the trust and backing of the

116 Central Bank Journal of Law and Finance, No. 1/2017 Alexandru M. Tănase population. Many times, interest rates are established with the evolution of the currency in mind, but there are clear cases in which the political factor interfered, especially during the general elections periods. The case of Romania is also illustrative from this point of view. During the early ‘90s, interest rates were established at high levels (end-year lending rates per annum: 86.4% in 1993, decreasing, but still very high, at over 55% in 1997) in order to alleviate the high depreciating pressure on the Leu. The situation could not be more different nowadays. Currently, the interest rate of the monetary policy is at a very low level of 1.75% per annum, in accordance with the data published by the NBR (see the result of the Board’s meeting dated 5 April 2017). Such a low level could have a positive impact on the lending to the real sector of the economy, but, at the same time, there has been a perverse negative impact. The extremely low level of refinancing rates (supporting the concept of “cheap money”) is good for stimulating production, service, trade etc., but it has a very negative impact on deposits, especially on the population’s deposits and saving attitude. Of course, there is no reason to save in a depreciating currency which, on top of it all, is not producing any meaningful interests. Moreover, the trust of the population in the currency is diminishing as the real purchasing power of the respective currencies (including strong currencies such as USD, EUR, GBP and others) is declining, especially if looked at in real terms. The situation of the Romanian Leu is very similar from this point of view. From a theoretical point of view, it should be noted that a strong currency should be supported by a strong economy. The opinion expressed by the British analyst, W. Rees- Mogg, in one of his articles written back in 1996, namely that the single currency of the European Union (the EUR introduced in 1997) should be supported by the economic and financial power of the states accepting it as their currency, was totally valid. Moreover, the cultural attitude of the respective nations would have a significant importance, noted W. Rees-Mogg17. Similar concepts were published by A. Kaletsky and this paper fully endorses these opinions as true as far as both the Romanian and the Moldovan Leu are concerned.

2.7. Major Milestones Romania started its transition to a market economy in December 1989 from a super- centralised and planned economy. The achievements to date could be labelled as mixed. On the positive, side a few fundamental ones are worth mentioning: first, on 29 March 2004 Romania became a NATO country and, second, on 1 January 2007 it became a full member of the European Union, one of the largest markets in the world and a powerful political and economic mechanism in the “old civilized” Europe. Third, with a lot of pluses and minuses, Romania has been a zone of geo-political stability in the Balkans over the last quarter of a century. All these are very important for Romania and for the whole Europe. On the other side, Romania, like many other countries in transition, has suffered

Central Bank Journal of Law and Finance, No. 1/2017 117 Two Currencies - Two Destinies. The Romanian Leu - The Moldovan Leu enormously and continues to suffer from the corruption plague. At the same time, Romania started to register large macro-economic disequilibria such as large trade and current account deficits, budgetary deficits (some of them large and persistent in certain periods of time), insufficient absorption of the EU funds and major setbacks in fighting inflation (hyper-inflation in some years). Also, during the last 27 years, Romania has lost an important advantage, namely its nil level of external indebtedness when the regime was changed in December 1989. The Romanian foreign debt reached a bewildering level of EUR 99.7 billion in 2012 (which has been the peak so far), especially if compared to its economic and commercial potential. Admittedly, with a level of 59.2% of foreign debt to its GDP18, Romania is not a Heavily Indebted Country (HIC), but if no restraining measures are taken, at least to slow down the accumulation of foreign debt, the situation could easily get out of control. The social negative impact could not be greater and the Greek lessons learnt could not be more relevant for other countries (including Romania and Moldova) in the current turbulent market conditions. „The ghost” of the uncontrollable Greek foreign debt (at 170% of its GDP) is haunting the Balkans!

In 2017, Romania will celebrate the 150th anniversary of its currency. Looking back, the Romanian Leu has had a long and, sometimes, difficult way. However, over the years, it could be said that the introduction of the Leu back in 1867 was of a crucial importance for Romania. The monetary chaos which had existed before (in which an amalgamated set of foreign currencies had been in circulation) was over. Ten years later, in 1877, Romania became an independent state following a war bravely fought by the Romanian army. This confers a special important place to the 1867 introduction of its own currency. However, a key challenge for the Leu’s very existence could be (final answer yet to be given by the Romanian authorities and the EU) the introduction of EUR as the official currency of Romania in a few years’ time. But this is a different story altogether!

3. THE MOLDOVAN LEU

3.1. “Young Currency” The Republic of Moldova (Moldova in this paper) became an independent state on 27 August 1991, in the aftermath of the Soviet Union’s dissolution. Because of this and in a very complex geo-political environment, the story of its currency is an interesting case. Before its independence, Moldova, like all the other 14 republics of the former Soviet Union, had used the Soviet Rouble and then for a short period of time the Russian Rouble. Also, for a brief period of time after its independence, Moldova had printed its own “coupons” before taking the bold decision to introduce its own currency. This happened on 29 November 1993, when, with the support of the IMF, it put in circulation the Moldovan Leu (the first banknotes were printed abroad, in France). From an

118 Central Bank Journal of Law and Finance, No. 1/2017 Alexandru M. Tănase economic point of view, some conditions for a stable currency had been met in those days, such as the lack of any foreign debt, the economic potential of the agriculture sector and, of course, the Moldovans’ will to have their own monetary signs. These premises were of major importance, but it should be noted that Moldova barely had any foreign currency reserves and had no gold holdings whatsoever at the time when this new currency was “born”. In the dissolution process of the former Soviet Union, Moldova opted for “no share of the foreign debt, no share of the international assets”. The starting point of “no foreign debt” was a major positive factor (although rapidly lost in the transition to a market economy), but the lack of any gold holdings has haunted the currency up to nowadays.

Figure 4: Moldova - The Moldovan Leu Banknotes Printed in 1994 and 2010 Source: The first Moldovan Leu printed in 1994, signed by the first Governor of the NBM and a new banknote signed by the second Governor (NBM website)

The economic potential of this country is quite good if compared to its geographic and human dimensions, but it is not used to the highest level. By the time of the introduction of its currency, Moldova had registered a sharp economic decline (-31% of GDP in 1994 and -3.2% in 1995, after four previous years of massive reductions of GDP during 1990- 1993). Inflation was extremely high (1,283% in 1993 and 587% in 1994) and the state budget deficits were also very high (approximately 5 - 8% of GDP). Despite the so called zero option (no foreign debt, no external assets), Moldova’s foreign debt started to accumulate at a rapid pace. The level of USD 700 million had been already reached by October 1996. By mid-1997, the same indicator had reached USD 1 billion, according to the figures published by the National Bank of Moldova (NBM). This represented 50% of the Moldovan GDP which was quite concerning. Moreover, over the next 20 years, the Moldovan foreign debt would build up to a staggering level of USD 6.6 billion (EUR 6.25 billion) by end-2016. This was already equal to approximately 100% of GDP. Nevertheless, the foreign currency reserves evolved reasonably well under these circumstances and even more so if the difficulties in developing its exports are taken into consideration.

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The Moldovan banking sector, which was important for the introduction and evolution of the Moldovan Leu, was quite different as compared to other countries in transition, including Romania. Moldova inherited from the former Soviet Union’s four branches of the former specialised banks, of which one for agriculture, one for industry, trade and services, one for financing the social sector and the last one for keeping the population’s savings. The four entities rapidly adjusted to the new realities and became universal banks after 1991. This is the short narrative of the four largest banks of the country in the early days of the transition: Moldova-Agroindbank, Moldindconbank, Banca Socială (Social Bank) and Banca de Economii (Savings Bank)19. In parallel, new private banks were established and started to develop. All commercial banks in Moldova started to apply international accounting standards in a process which is yet to be finalised. In parallel, in August 1992, Moldova became a full member of the IMF and the World Bank Group following a preparatory process which was fully supported by the Dutch and Romanian authorities. The memberships in these financial organisations represented an important achievement for the new Moldovan authorities. These laid out the foundations for the new Moldovan currency which was to be issued one year after. The celebration of the 25th anniversary of Moldova’s membership this year is entirely justified. During the initial years of the Moldovan Leu’s existence, the NBM conducted a very restrictive policy. The refinancing rates for commercial banks reached an unusual level of 377% in March 1994. The minimum reserves requirements for commercial banks were kept at very high levels (for instance, in 1994 at approximately 28%). The refinancing level was then relaxed to 19% in April 1996 and the minimum reserves requirements were reduced from 12% as of end-1995 to 8% by end-1996. In the first part of its transition, Moldova was a country which exemplarily implemented all the agreements concluded with the IMF and other International Financial Institutions (IFIs), especially with regard to the credit level. Based on the good results in the implementation of reforms, Moldova succeeded in obtaining favourable quotes from reputable international agencies during the ‘90s (see Table 4). However, this advantage has been lost due to the severe political, financial and banking developments during the last 3-5 years to date. For instance, a new recent quote from Moody's Investors Service was of only B3 on 13 January 2017 (with stable outlook) and this was possible only after a new agreement with the IMF20.

Based on the good results in the implementation of reforms, the Moldovan Leu managed to remain stable in the first 5 years of circulation. In November 1993, the first exchange rate for Leu was established administratively by the NBM at 3.85 MD lei/USD. By end- 1994 the depreciation process was quite mild, at 4.27 MD lei/USD, at 4.50 MD lei/USD as of end-1995 and at 4.66 MD lei/USD by the end-1997. Under these circumstances, Moldova accepted the provisions of Article VIII of the IMF Charter on 30 June 1995,

120 Central Bank Journal of Law and Finance, No. 1/2017 Alexandru M. Tănase before Romania, which only signed Article VIII on 25 March 1998, despite the fact that Romania has been a full member of the IMF since 15 December 1972. The IMF members accepting these provisions undertake to abstain from the introduction of any restrictions regarding international payments and current account transfers and to eliminate any discriminatory practices on foreign currency regimes. This means, de facto, a current account currency convertibility. For capital account convertibility, the fulfilment of more requirements is needed first and this latter type of convertibility is still an objective for many countries, including Romania and Moldova, even nowadays.

Table 3: Transition countries which accepted the provisions of Article VIII of the IMF Charter (as of 20 December 1996)

Country Date Croatia 29 May 1995 Czech Republic 1 October 1995 Estonia 15 August 1994 Georgia 20 December 1996 Kyrgyzstan 29 March 1995 Latvia 10 June 1994 Lithuania 3 May 1994 Kazakhstan 16 July 1996 Republic of Moldova 30 June 1995 Poland 1 June 1995 Slovakia 1 October 1995 Slovenia 1 September 1995 Russian Federation 1 June 1996 Ukraine 24 September 1996 Hungary 1 January 1996 Source: IMF - International Financial Statistics (IFS) - May 1997

Coming back to Moldova, this was a good achievement back in those days and it reflected as such in the relative stability of the Moldovan Leu. However, the evolution of this new currency was to follow more dramatic developments in the coming years. First of all, a very steep depreciation followed the 1998 crisis, as presented in Figure 5. The second one was to follow after 2014.

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Figure 5: Moldova – Moldovan Leu vs. USD, EUR and RON Source: Compiled based on data published by the NBM (Interactive Data Base)

While the introduction and the trend of this “young” currency were good in the first part of its history, the current status of the currency is not so great, however. A strong economic recovery is now required to bring stability for the Moldovan Leu. This implies the restructuring of large state owned companies which currently register losses or receive subsidies from the budget and the substantial increase in exports, including to the CIS countries. Also, the strong control of the foreign debt should/must be a priority for the current Moldovan authorities. An adequate structure of the foreign debt is desirable, but realistically maybe Moldova is not in the position to juggle/choose amongst its creditors. It simply has not got enough borrowing capacity to be able to diversify the sources of its external financing. The latest loan granted by Romania, of EUR 150 million, in October 2015 (the second tranche of EUR 50 million was disbursed in February 2017) was more of an emergency loan extended by a friendly neighbouring country than a normal access to international capital markets. The Moldovan foreign debt has had and will continue to have a material impact on the fate of the Moldovan Leu. In addition, the debt accumulated by the companies established in Transnistria has been and will continue to be a topic of heated discussions in the Moldovan society, as the break-away unrecognized republic of Transnistria has been supported by the Russian Federation ever since Moldova’s independence in August 1991. As such, the question was and still is whether Moldova should pay for the debt resulting from the transactions of Transnistrian entities. Moldova has been and will continue to be externally vulnerable because of its almost total dependence on energy imports from the Russian Federation and other CIS countries. In the winter of 1996, Moldova was forced to introduce the “state of emergency” as the

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Russian Federation reduced its exports of oil, natural gas and energy and asked for the upfront payment of the accumulated debt. In more recent years, Moldova had another type of difficulties generated by restrictions and by the total prohibition of exports of some traditional products (wine, cognac, meat, vegetables, fruits etc.) on the CIS markets. This was supposedly done for phytosanitary reasons, but all external analysts of the Moldovan developments agree that the restrictions were mainly geo-politically motivated.

3.2. Recent Evolutions The status of the Moldovan Leu, both internally and externally, has been under heavy pressure during the last 5 years. The supervision of the NBM up to end-March 2016 was weak, to say the least. The Moldovan banking sector was plagued by severe scandals, of which the so-called “the Moldovan laundromat” and the huge banking fraud (see Box 2) were the most damaging for the Moldovan Leu. Regarding the first one, in summary, some Moldovan banks were involved in money laundering transactions involving Russian funds, Russian entities, commercial banks from Moldova, the Russian Federation, the Baltics and Moldovan state’s legal entities/authorities (courts, prosecutors, bailiffs, public notaries, lawyers etc.). According to independent analysts, some USD 20 billion (more recent figures put it at USD 22 billion) were “laundered” from the Russian Federation to off-shore jurisdictions in rather sophisticated schemes. The debtor entered into fictitious commercial contracts (with no material substance) concluded between two Russian companies and did not pay its “obligations” to the creditor. The original contracts were guaranteed by a Moldovan guarantor (usually homeless persons from Moldova) in order to involve the Moldovan jurisdiction. Therefore, the creditor asked the Moldovan banks to take the money from the account of the guarantor, previously provided with the Russian counter-guarantee (or cash deposits in accounts open with the Moldovan banks by the Russian banks). The Moldovan banks acted on these transactions as a commission fee- taker, based on a decision of a Moldovan court and under the order of a Moldovan bailiff. All these dubious transactions were automatically reported by the banks to the NBM and to the then Centre for Fighting Corruption and Combating Terrorism, currently the Anti- Corruption National Centre. Back in 2014, the Moldovan authorities asked their Russian counterparts about the origin of the money transferred from the Russian accounts with the Moldovan banks to Latvian banks and then to off-shores jurisdictions. The Russian Federation never responded. All these transactions had been implemented for years, up to May 2014, when the whole scheme became public. During 2016-2017 many judges and bailiffs involved were arrested and many managers of the involved banks (and from the NBM) were fired/dismissed/arrested/had the banking administrator licences revoked. However, this was too little, too late! The damage was done and the Moldovan Leu entered into a continuous process of depreciation (see Figure 5). One collateral negative impact of money laundering and of the banking fraud toxic transactions was the unprecedented increase in non-performing loans in the Moldovan

Central Bank Journal of Law and Finance, No. 1/2017 123 Two Currencies - Two Destinies. The Romanian Leu - The Moldovan Leu banking sector, as presented in Figure 6 below. The sharp increase from 9.79% as of end- September 2015 to 16.31% as of end-2016 was mainly caused by two key trends (one more negative than the other): a) the absolute increase in non-performing loans from MD lei 3,877.24 million to MD lei 5,669.86 million during this period which has to do with the state of the economy and with the economic attitude of a society traumatised by the banking fraud; and b) a more worrisome trend of decline in the total loans from MD lei 39,613.06 million to MD lei 34,761.27 million. The second trend had a substantial impact on the economic growth of the country and hence on the recent weakness of the Moldovan Leu in a turbulent regional geo-political context.

Figure 6: Moldova – Non-Performing Loans (% of total loans) Source: Computed based on the NBM’s data consulted on 28 February 2017

In addition, another serious problem of the Moldovan banks was related to the very existence of non-transparent shareholders in almost all the banks in the country (apart from a few medium and small banks with reputable foreign shareholders such as Mobias Banca (part of SocGen Group) and BCR Chisinau (part of Erste Group). This led to or allowed “raiders’ attacks” on the shares of some of the largest banks, such as Moldova- Agroindbank and Victoria Bank and of some insurance companies. In this respect, the supervision of the National Bank kept failing until a new Governor was appointed by the Moldovan Parliament (Decision no. 31 dated 11 March 2016 with the starting date of 11 April 2016) when measures to correct this unacceptable situation started to be implemented. This issue is not over yet and the (already registered) unfavourable impact on the currency will continue for a while.

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Box 2: Moldova - The Huge Banking Fraud, 2012 - 2015 From 2012 up to the first part of 2015, the Moldovan banking sector suffered from heavy monetary and credibility losses following the fraudulent acts performed by a group of persons, amongst which high level politicians, unscrupulous shareholders and bankers. The crooks benefited from the tacit approval and/or non-actions of many other Moldovan authorities. This was normally called in banking literature, organized crime! Basically, three banks (Banca de Economii, Banca Socială and Unibank) entered into a very dangerous game of extending loans to companies related to one key shareholder/some of the shareholders (yet to be clarified)21. These companies were related amongst themselves, had no credit history and, moreover, had no credibility and/or intention to repay the loans extended fraudulently to the banks. The figures of the total such loans were originally disputed, but finally the National Bank of Moldova had to issue emergency loans of total MD Lei 14 billion (USD 1 billion at the then exchange rates) to the three banks involved. The figures were later confirmed by the Kroll Report (a special audit) commissioned by the Moldovan authorities as a conditionality of the international financial institutions and other external partners of Moldova. These emergency loans were issued based on a guarantee issued by the Ministry of Finance. The loans were not recovered and finally the Moldovan state budget had to take over such fraudulent loans to the public debt. People protested in Chisinau and other Moldovan cities against such action on behalf of the Moldovan authorities, but all was to no avail. Promises to recover the lost money were empty ones. The three banks involved were initially put under special supervision (NBM’s Decision no. 248 dated 27 November 2014) and finally their licences were withdrawn on 16 October 2015 following a decision of the Executive Board of the NBM. Liquidators were appointed as of the same date. As of 1 February 2017, the amount recovered by the three banks in liquidation was at a very modest level of MD Lei 722.85 million (approximately 5% of the loss). As of the same date, the guarantee issued by the Ministry of Finance was repaid at the level of MD Lei 903.94 million. There are no credible hopes that all the money would be finally recovered and that the guilty persons would be punished. This was a heavy blow to the Moldovan Leu (see Graph 2 on the exchange rates on the last 3 years) as the international financial community stopped any financing to Moldova for more than 2 years, the public debt increased sharply and the trust of the population in the banking system and the currency has fallen dramatically.

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Under such circumstances, corroborated with the second large scandal presented above, the currency sharply depreciated to 20.87 lei/EUR and to 20.04 lei/USD, respectively, as of end-2016. During 2015-2016, the level of 22.00 lei/EUR was exceeded which shows the weakness and the fragility of a young currency unable to weather the extreme conditions derived from scandals, frauds and a struggling economy of a country at the crossroads. An incipient and fragile appreciation trend was experienced by the MD Leu in the first half of 2017, appreciation related to the new external financing ensured by Moldova from IFIs and the EU.

4. A SHORT ECONOMIC AND MONETARY PARALLEL

From the data presented below, in Table 4, it is quite clear that it is a difficult, if not a risky task, to draw an economic and monetary parallel between these two neighbouring countries, with common historical roots, the same language and a common name for their currencies. In a way, it is easier to let the figures speak for themselves. Nevertheless, a few features could be safely underlined: . The history of the Romanian Leu is much older (150 years in May 2017) and richer than that of the Moldovan Leu (24 years in November 2017), which by any international standards is a “young currency”. The present status of both currencies shows, in 2017 and in the short term, relatively stable period of times. Their respective future in the medium and long term needs to be closely monitored, admittedly for very different reasons; . Both currencies followed and/or suffered from the vagaries of the economic and historical developments in both countries. However, it would only be fair to say, that the “fragility” of the Moldovan Leu was determined by other reasons as well (geo- political developments in the region, loss of confidence following large money laundering transactions and, more recently, the severe banking fraud of 2012-2015 and others); . Both countries started the transition process (Romania in December 1989 and Moldova in August 1991) with a huge potential positive financial advantage, namely no foreign debts. This was lost in a very short period of time by both countries, with heavy consequences on the fate of the Romanian Leu and of the Moldovan Leu, respectively; . Although they have a common name (Leu for singular and Lei for plural), the two currencies have evolved distinctly as the two countries followed quite different paths. Romania became a NATO country in March 2004 and a EU full member on 1 January 2007, while Moldova is still at the crossroads (following the presidential elections in Moldova in 2016, the pro-CIS orientation of Moldova is more and more evident);

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. The transition processes started in December 1989 in Romania and in August 1991 in Moldova, so they are similar from a historical prospective. Furthermore, both Romania and Moldova suffered, during the last quarter of a century, from a wild accumulation of wealth and political power by the newly born oligarchs. Both in Romania (especially in the first part of the transition) and in Moldova, the local oligarchs have left very negative marks on the evolution of their respective currencies; . The performance of the NBR in managing the Romanian Leu was adequate, despite the very high level of accumulated foreign debt up to date. The case of Moldova is more complex. The lack of proper supervision of the banking system on money laundering and the severe banking fraud has had dire consequences. A Kroll investigation into the USD 1 billion fraud is still undergoing (Kroll - The Second Report (II) is still to be finalized as of June 2017). From this point of view, Moldova’s case is not closed, a lot of political pressure is exercised and, finally, “the jury is still out”, as not much was recovered so far, if any; . The economic potential of Romania (which will give strength to the Romanian Leu) is high. Within the EU, Romania is well positioned to harness this potential. Moldova also signed a Deep and Comprehensive Free Trade Agreement (DCFTA) with the EU in June 2014 (with full effect from 1 July 2016), but the benefits are yet to be fully exploited. Moreover, one of Moldova’s key commercial partners (the Russian Federation) still has a lot of restrictions regarding Moldova’s key-exports (mainly agricultural products). In addition, almost one million persons, mainly young and educated Moldovans, left the country to work abroad. A recent study published by the United Nations signalled that Moldova (and other countries as well) may lose more than 40% of its population by the end of this century22. This will have dire consequences from the social and economic point of view; . Both currencies benefited during the last two decades from significant remittances from abroad. The large transfers considerably helped both currencies to stay afloat, but in both cases, the trends are on the declining side. Pressure on each currency will continue. Romania has continued to increase its foreign debt during 2017 by some EUR 2 billion, while Moldova is still struggling to bring more foreign direct investors in the country. Both developments will be very challenging to handle and to keep under control; . As a general remark, it is safe to say that the destinies of the two countries were unkind at times (but not always). These situations were scrupulously reflected in the fate of their respective currencies. This was even more so during the crisis times. The years of 1867, 1877, 1917, 1941, 1989, 1991 and 2008 (to select just a few) are examples of many major historical dates with profound implications (both positive and negative ones) for the destinies of both currencies.

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Table 4: Romania and Moldova - Summary of the Last Two Tumultuous Decades Romania Moldova 2016 Key Indicators Units 2016 or 1996 or 1996 latest latest Population Million 22.6 19.8 4.3 3.55 GDP Million of 109,515,000 711,103 8,828 121,851 ROL/RON/Lei/ MD Lei GDP, annual changes % -6.6 3.9 -8.0 -0.5 GDP/GNI per capita USD 1,572 9,500 504 2,240 (World Bank - 2015) Inflation, CPI, annual % 38.8 -1.5 23.5 6.4 average State budget balance % of GDP -4.0 -3.0 -7.5 -2.2 Gold Holdings Million ounces 2.82 3.33 0 Not material Gold Holdings at market Million 913 3,634 0 Not value USD/EUR material International Reserves Million 551 35,208 366 2,091 (without gold) USD/EUR International Reserves as Number of 1.1 6.1 3.0 5.1 months of imports months External Debts Million 8,332 94,253 795 6,688 USD/EUR Currency Exchange Rates ROL/RON/ 4,035 4.54 4.65 20.87 (end-year) MD Lei Lei/USD Lei/EUR Foreign Debt to GDP % 23.5 59.2 41.4 100.0 Broad money (M3) to % 27.7 9.3 15.3 27.3 GDP Re-financing interest % 42.0 1.75 35.3 8.0 rates International Ratings - Moody’s Ba3 Baa3 Ba2 B3 - S&P BB- BBB- na na - Fitch na BBB- B na Sources: Table compiled based on the EBRD - Transitions Reports (various editions); IMF - IFS Yearbooks (various editions up to 2016); Data of National Institute of Statistics (Romania) and National Bureau of Statistics of Moldova, respectively; Data published by the National Bank of Romania and National Bank of Moldova, respectively; Reuters; na = not available; GDP/GNI are according to World Bank Atlas for 2015

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Notes to Table 4: a. Unless otherwise stated, data for 1996 for both Romania and Moldova were reported in relation to USD, while the 2016 data were reported in relation to EUR; b. Exchange rate for end-1996 of USD against EUR was at 0.9477; c. Moldova’s population estimated for end-2016, without Transnistria and the city of Tighina (Bender); d. Moldova’s rating from Moody’s was only obtained in January 2017, following the agreement for a new program with the IMF; e. Population of Romania as of 1 July 2015; GDP and state budget deficit for 2015 - (Anuarul Statistic al României - 2016);

5. CONCLUSIONS

There are no easy conclusions to this paper as any such conclusions could be sensitive in the present geo-political environment from the region. By the way of concluding, though, it would be fair to say that the history of both the Romanian Leu and of the “younger” Moldovan Leu and, even more so, their present respective status are just mere reflections of their economies, domestic monetary and fiscal policies, international context and, more importantly, the population’s attitude towards their monetary signs. The summary in Table 4 above tried to put “face-to-face” the two currencies, compare their evolutions in the last two decades and finally to show their fortunes and their troubles all along. One clear red-line could be easily derived from the old and more recent developments described in details in this paper: a currency is strong(er) as long as it is supported by a healthy and robust economy. Building such economies should be national goals. Adherence to them by the whole community, local authorities, commercial banks, central banks, governments and politicians is crucial. Without all moving together in the same direction and in a well-coordinated manner, both the Romanian Leu and the Moldovan Leu will not flourish. Their current good potentials are there waiting to be harnessed. Will this happen? One can only hope.

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NOTES

1 See A. Green - 25 of Oscar Wilde's Wittiest Quotes - 16 October 2014 2 For the history of CEC Bank, see St. Petre Kirson, Casa de Economii şi Consemnaţiuni 1864-2004: 140 ani de existență, Bucharest, 2004. 3 A more detailed presentation of the first Romanian monetary instruments, their status and the historical context in which these were issued was done by Costin C. Kirițescu in “Sistemul Monetar al Leului și Precursorii Lui”, I-III, București, 1964-1971. Very important data on the monetary situation of Romania during the period between the two World Wars are presented in Enciclopedia României, Vol. IV which is the relevant chapter on the monetary and financial policies of Romania. This chapter was also written by C. Kirițescu. At the same time, very useful information regarding the history of the Romanian Leu was included in C. Kirițescu - Moneda - Mică Enciclopedie, Ed. Științifică și Enciclopedică, București, 1982, page 201 and the following ones (all in Romanian language). See also Footnote 9. 4 See also A. Tănase - Gold, International Reserves and Foreign Debt. The case of Romania - Central Bank Journal of Law and Finance, No. 2/2016 5 See L. Croitoru - Două clarificări privind “valoarea aurului” și nivelul veniturilor salariale la BNR - OpiniiBNR.ro - 5 September 2016 (Romanian language) 6 See V. Andrei - Despre administrarea rezervei de aur a României - OpiniiBNR.ro - 10 August 2016 (Romanian language) 7 See also S. Marițiu, Din istoria monetară a Romaniei - BNR, 2006 (Romanian language) 8 See C. Kirițescu - Bătrâna Doamnă sub cnutul luptei de clasă - Revista Magazin Istoric - nos. 10 and 11 - October and November 1996, pages 33-35 (for both numbers) (Romanian language). 9 For more details see BNR - Bancnotele României (coordinator Academician and Governor M. Isărescu), Vol 3 - Emisiunile de Bancnote Românești în Perioada 1929- 1947 - Istorie și Tehnologie - by S. Marițiu and R. Cîrjan, București, 2011 (Romanian language). 10 See C. Kirițescu - Moneda - Mică Enciclopedie, Ed. Științifică și Enciclopedică, București, 1982, pages 292 -293 (Romanian language) 11 Other socialist countries followed Romania and joined the IMF such as Hungary on 6 May 1982 and Poland on 12 June 1986. Czechoslovakia was an original member up to 31 December 1954. It re-joined on 20 September 1990 up to 1 January 1993, when the country split (IMF website). 12 The term “Cursul Comercial Unic” was abandoned in 1990, in the aftermath of the December 1989 events.

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13 The Ministry of Finance has been reorganized many times during the last 27 years since 1989, including as the Ministry of Public Finance and the Ministry of Economy and Finance. The Ministry of Foreign Trade and International Economic Cooperation and the State Planning Committee were abolished after 1990. 14 NBR - Monthly Bulletins no. 1-3/1993 15 See Government Decision no. 469/1996 for financing the Energy Program and the Methodological Norms no. 12/1996 issued for its implementation (Romanian language). 16 See Marițiu, S., Din istoria monetară a României - BNR, 2006 (Romanian language) 17 W. Rees-Mogg - An impoverished currency in The Times - 10 October 1996, page 20 18 IMF - Central, Eastern and South-eastern Europe - How to get Back on the Fast Track” - May 2016 19 Banca de Economii, Banca Sociala and Unibank entered into a liquidation process in 2015 in the aftermath of the large fraud in the banking sector from 2012-2014 of around USD 1 billion (see Box 2 below). 20 In November 2016, Moldova signed a new programme with the IMF for the amount of USD 178.7 million. The conditionality of this last programme is rich, especially on the banking sector supervision and restructuring of this key sector. As of end-February 2017, an amount of USD 35 million was disbursed to Moldova, with the review of a new tranche undertaken in April 2017. 21 See communications on the three Kroll Reports on the NBM’s website, consulted on 13 February 2017 and 13 April 2017 (the fourth investigation Report by Kroll and Steptoe and Johnson). Some 40 persons and at least 75 companies related to the key shareholder were involved. 22 See Clare Nuttall - BNE Intellinews - Moldova, Bulgaria, Poland, Albania and Latvia to lose more than 40% of their population by 2100 (posted on website on 23 June 2017)

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REFERENCES

1. Andrei, V., Despre administrarea rezervei de aur a României - OpiniiBNR.ro - 10 August 2016 (Romanian language) 2. Croitoru, L., Două clarificări privind “valoarea aurului” și nivelul veniturilor salariale la BNR - OpiniiBNR.ro - 5 September 2016 (Romanian language) 3. Dăianu, D., Funcționarea economiei și echilibrul extern, Ed. Academiei Române, București, 1992 (Romanian language) 4. Dogaru, I.; Emisiuni de monede și bancnote românești, București, 1984, pages 22, 23 and 63 (Romanian language) 5. Green, A,; 25 of Oscar Wilde's Wittiest Quotes - 16 October 2014 6. Green, J.E.; Isard, P., Currency convertibility and the Transformation of Centrally Planned Economies - IMF Occasional Papers, 1991 7. Isărescu, M., România este în aceeași grupă de risc cu Polonia și Ungaria - Adevărul Economic nr. 10 (208), 8 - 14 martie 1996 (Romanian language) 8. Kaletsky, A., America is ready to benefit from growing strength of the dollar - The Times - 12 September 1996 9. Kirițescu, C.; Bătrâna Doamnă sub cnutul luptei de clasă - Revista Magazin Istoric - nos. 10 and 11 - October and November 1996, pages 33-35 (for both numbers) (Romanian language) 10. Kirițescu, C.; Moneda - Mică Enciclopedie, Ed. Științifică și Enciclopedică, București, 1982, pages 292 -293 (in Romanian language) 11. Kirițescu, C., Relații valutare financiare internaționale, Ed. Stiintifică și Enciclopedică, București, 1978 (Romanian language) 12. Kirson, St. P.; Casa de Economii şi Consemnaţiuni 1864-2004: 140 ani de existenţă, Bucharest 2004 13. Lanchner, D., A Romanian shopping list - Global Finance - April 1997 14. Marițiu, S., Din istoria monetară a României - BNR, 2006 (Romanian language) 15. Marsh, V., Romania clampdown betrays anxiety for Leu - Financial Times - 25 March 1996 16. Newman, A., Solid Gold - Investors Chronicle - 17 June - 23 June 2016, pages 26-30

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17. Nuttall, C., BNE Intellinews - Moldova, Bulgaria, Poland, Albania and Latvia to lose more than 40% of their population by 2100 (posted on website on 23 June 2017) 18. Rees-Mogg, W., An impoverished currency - The Times - 10 October 1996 19. Rowen, H., Declining Dollar's Impact on Trade is Exaggerated, The Washington Post, 6 October 1991 20. Tănase A., Foreign Direct Investment in Romania - Encyclopaedia of Romania - 1996, Sterling House, London, February 1996 21. Tănase, A., 1985 - anul unor fluctuații valutare extreme - Revista Economică nr. 5/1986; 1986 - anul unor fluctuații valutare ample - Revista Economică nr. 4/1987 (both in Romanian language) 22. Tănase, A., COMMENT: Is the level of Romania’s foreign debt a cause for concern? - published by BNE Intellinews, London, on 3 June 2016 23. Tănase, A., Interview granted to Profit, Banks and Finance Magazine, Chișinău, Republic of Moldova - Issue no. 4/2016 24. Tănase, A., Re-eșalonarea datoriilor externe - Revista Economică nr. 5/1986 (Romanian language) 25. Tănase, A., The Leu Status and Foreign Direct Investment in Romania - The Official Guide to Romanian Industry and Commerce, 1997 26. Tănase, A., Măsuri pentru introducerea și susținerea convertibilității leului - București, ASE - 1997 (Romanian language) 27. Tănase, A., Gold, International Reserves and Foreign Debt. The case of Romania - Central Bank Journal of Law and Finance, No. 2/2016 28. Tănase, A., and Pătrașcu, V., Moldova - IMF and World Bank Group Membership - The 25th Anniversary: Achievements and Challenges, Revista Profit, Chișinău, no. 7- 8/2017 (English and Romanian languages) 29. ***, EBRD - Transition Reports (various editions, including Transition Report Updates) 30. ***, Government Decision no. 469/1996 for financing the Energy Program and the Methodological Norms no. 12/1996 issued for its implementation (Romanian language) 31. ***, IMF - Central, Eastern and South-eastern Europe - How to get Back on the Fast Track” - May 2016

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32. ***, IMF - World Economic Outlooks, various editions 33. ***, NBM - Monthly Bulletins - 1993 and onward 34. ***, NBM - On Kroll Report (see NBM’s website, consulted on 13 February 2017) 35. ***, NBR - Monthly Bulletins - 1993 and onward 36. ***, BNR - Bancnotele României (Coordinator Academician and Governor M. Isărescu), Vol. 3 - Emisiunile de Bancnote Românești în Perioada 1929-1947 - Istorie și Tehnologie - by S. Marițiu and R. Cîrjan, București, 2011 (Romanian language) 37. ***, NBR - Annual Reports of the Balance of Payments and International Investment Position of Romania (various editions) 38. ***, World Bank - Atlas for 2015.

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Supervisory Colleges: Evolving Structures and Diverse Practices. Selected Issues.

Cristina Elena Moldovan*

Abstract

The exchange of information and the continuous collaboration between competent authorities are essential for enhancing harmonised supervisory practices and decisions regarding the cross-border groups of credit institutions. Against this background, Supervisory Colleges have evolved as a forum of discussions, involving home and host authorities, for the planning and the exercise of supervisory tasks jointly, including assessments and the exchange of information regarding aspects of ongoing supervision, as well as for the preparation for and the management of emergency situations. Currently, the European prudential legal framework for credit institutions lays down specific situations for establishing Colleges of supervisors to help the development of a common understanding of risk among college members and to promote an aligned work programme for addressing the specific vulnerabilities of a cross border banking group. The author presents the current framework regarding the functioning and the purpose of the Supervisory Colleges, with an emphasis on the legal effects of the joint decisions on the credit institutions concerned.

Keywords: banking supervision, joint decision, Supervisory Colleges, Capital Requirements Directive

JEL Classification: E58, K100

* Senior legal adviser, National Bank of Romania, Master’s Degree in Banking Law The views and opinions expressed in this article, including any errors or omissions, are solely those of the author in her private capacity.

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LIST OF ABBREVIATIONS

BRRD Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council CEBS Committee of European Banking Supervisors CRD Capital Requirements Directive, Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC CRR Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 EBA European Banking Authority ECB European Central Bank ITS Implementing technical standards NPL Nonperforming loans SREP Supervisory review and evaluation process

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1. THE LEGAL NATURE AND THE PURPOSE OF THE SUPERVISORY COLLEGES To ensure a well-functioning internal market, harmonised supervisory practices and decisions regarding the cross-border groups of credit institutions are required. The exchange of information and the continuous collaboration between competent authorities are essential instruments for the effective supervision of international banking groups.1 Based on these premises and considering that, although necessary, bilateral consultations are not sufficient for ensuring a holistic supervisory approach, to strengthen the supervision of cross-border banking groups and support the development of a consistent and effective framework, in 2010, CEBS, published some guidelines (i) on the operational functioning of Supervisory Colleges (GL341) and (ii) on the joint assessment of the elements covered by the supervisory review and evaluation process, as well as on the joint decisions on the capital adequacy of cross-border groups (GL39)2. In the context of the implementation of the Capital Requirements Regulation (CRR) and the revised CRD, the guidelines were replaced by the directly applicable technical standards covering (i) the operational functioning of colleges, (ii) the joint decision on institution-specific prudential requirements, (iii) passport notifications, as well as (iv) the information exchange between home and host supervisors in relation to institutions operating through branches. Currently, the European prudential legal framework for credit institutions lays down specific situations for establishing Colleges of supervisors, enabling the consolidating supervisor to conduct effective supervision on a consolidated basis by creating a platform for exchanging information regarding aspects of ongoing supervision and also for the preparation for and the management of emergency situations in order to help the development of a common understanding of risk among college members and to promote an aligned work programme for addressing the specific vulnerabilities of a cross border banking group’s assessments and information exchange.3 Thus, the Colleges of supervisors are flexible structures without legal personality4, constituted of representatives of the competent supervisory authorities from the home Member State and from the host Member State of a banking group. To ensure consistency and enable the EBA to perform its tasks as provided for in Regulation (EU) No 1093/2010 of the European Parliament and of the Council5 and in Article 116 of Directive 2013/36/EU, the EBA participates in all colleges as a member. According to Article 2 of Regulation (EU) 2016/98, for the purpose of identifying the members and potential observers of the supervisory college, the consolidating supervisor shall establish the mapping of a group of institutions, which would identify the group entities in the Union or a third country and which would describe for each group entity its nature, location, the authorities involved in its supervision, the applicable prudential exemptions, its importance for the group and importance for the country in which it is authorised or established as well as the criteria for determining that importance, as a vital element for the identification of college members and potential observers.

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In this context, pursuant to Article 3(1) of Delegated Regulation (EU) 2016/98, the consolidating supervisor shall invite the following authorities to become members of the college: a. The competent authorities responsible for the supervision of institutions which are subsidiaries of an EU parent institution or of an EU parent financial holding company or of an EU parent mixed financial holding company and the competent authorities of host Member States where significant branches are established; b. The ESCB central banks of Member States that are involved, in accordance with their national law, in the prudential supervision of the legal entities referred to in point a, but which are not competent authorities; c. The EBA. Provided that the members of the college are informed in advance, the consolidating supervisor may invite the following authorities to participate in the college as observers (i) the competent authorities of host Member States where non-significant branches are established, (ii) the supervisory authorities of third countries where institutions are authorised or branches are established, (iii) the ESCB central banks which are not empowered by national law to supervise an institution authorised or a branch established in a Member State, (iv) the public authorities or bodies in a Member State, which are responsible for or involved in the supervision of a group entity, including the authorities responsible for the prudential supervision of the group's financial sector entities or the competent authorities responsible for the supervision of markets in financial instruments, the prevention of the use of the financial system for the purpose of money laundering and terrorist financing, or consumer protection. The consolidating supervisor shall submit the draft mapping to the abovementioned authorities, inviting them to provide their views and indicating the appropriate deadline for the submission of these views. Authorities receiving an invitation to become members or observers acquire this status upon acceptance of the invitation6. Supervisory Colleges work based on the written coordination and cooperation arrangements determined after the consolidating supervisor’s consultation with the concerned competent authorities. These arrangements should cover all areas of college work, including: (i) a description of the arrangements for exchanging information and for the treatment of confidential information and operational aspects of college work, (ii) the framework for the planning and coordination of supervisory activities in going concern situations and in preparation for and during emergency situations, (iii) arrangements between some college members involved in specific college activities such as those performed through specific substructures of the college, (iv) processes of coordinating the relevant input as well as the responsibilities and role of the consolidating supervisor in

138 Central Bank Journal of Law and Finance, No. 1/2017 Cristina Elena Moldovan communicating that input through the group-level resolution authority as defined in Article 2(1)(44) of Directive 2014/59/EU of the European Parliament and of the Council to the resolution college, (v) the scope and level of involvement of observers, if any, in the college, (vi) entrustment of tasks and delegation of responsibilities.

The process of concluding and amending the written arrangements is led by the consolidating supervisor who has to ensure that the members have the possibility to provide comments and observations.

Against this background, the Colleges of supervisors provide a framework for the consolidating supervisor, EBA and the other competent authorities involved in performing the following tasks: (i) the exchange of information between them and the EBA, (ii) agreeing on voluntary entrustment of tasks and voluntary delegation of responsibilities where appropriate, (iii) determining supervisory examination programmes based on a risk assessment of the group, (iv) enhancing the efficiency of the supervision by removing unnecessary duplication of the supervision requirements without prejudice to the options and discretions available in Union law, (v) consistently applying the prudential requirements across all the entities within a group of institutions, (vii) adequate coordination and collaboration with the competent authorities of a third country, where applicable, (f) planning and coordination of supervisory activities in cooperation with the competent authorities involved, and if necessary with the ESCB central banks, in preparation for and during emergency situations, including adverse developments in institutions or in financial markets by using, where possible, the existing channels of communication for facilitating crisis management.

The establishment of colleges does not affect the obligations provided by the law for the supervisory authorities since their purpose is to constitute a tool for a stronger cooperation through which competent authorities can reach an agreement regarding the key supervisory tasks. Colleges are a complementary supervisory tool, the cross-border dimension of the supervisor's activity, which do not compete with its tasks, according to national law.

In terms of legal effects, this perspective does not result in a conflict with the domestic law, but translates in an inclusive manner, given that, in the exercise of its prudential mandate, the competent authority is held to observe the conclusions of the College written in the joint decision.

Consequently, the national legal regime, the manner to perform the supervisory tasks, the instruments and the legal grounds for issuing supervisory acts by the authority stand applicable.

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2. THE ESTABLISHMENT OF THE SUPERVISORY COLLEGES, PURSUANT TO THE CAPITAL REQUIREMENTS DIRECTIVE7

Directive 2009/111/EC amending Directive 2006/48/EC8 laid down the establishment of the Colleges of supervisors, argued by the fact that it is essential that competent authorities effectively coordinate their actions with other competent authorities and, where applicable, with central banks, for the consolidation of a common framework for the management of crises, including for the reduction of systemic risk. To this end, the Colleges of supervisors should facilitate the management of ongoing supervision and emergency situations.

The revised version of the banking directive, Directive 2013/36/EU9, along with the implementing regulations, lays down a more generous legal framework regarding the establishment and the functioning of the Colleges of supervisors. Nonetheless, the main instruments for the implementation of the framework concerning the Supervisory Colleges in the EU are the guides elaborated by the European Banking Authority, as well as the implementing regulations adopted by the European Commission. Thus, the establishment and the development of Colleges is not the result of visionary regulatory progress through CRD III and/or CRD IV, and not a direct consequence of the 2007/8 crisis, but the result of the increasing complexity of financial groups and the increasingly pronounced cross-border nature of financial institutions. As against the CRD III, the CRD IV took a step forward for harmonizing supervisory practices by (i) involving the EBA and its increasing role within Colleges; (ii) the issuance of RTSs with direct legal effect; (iii) the issuance of guidelines, applicable to national competent authorities and institutions. Against this background, the CRD regulates, in article 51 and article 116, two situations for the establishment of the Colleges of supervisors with the aim of reaching a joint decision, as follows: d. The designation of a branch as being significant, by means of a joint decision, upon the request of the competent authorities of a host Member State to the consolidating supervisor or to the competent authorities of the home Member State (article 51 of Directive 2013/36/EU); and e. The consolidating supervisor shall establish Colleges to facilitate the exercise of the tasks from Article 112, 113 and 114 (1) and to ensure, where applicable, the adequate coordination and collaboration with the relevant competent authorities from third countries (Article 116 of Directive 2013/36/EU). In both cases, the establishment and the functioning of the colleges are based on written coordination and cooperation arrangements, set after the consultation with competent

140 Central Bank Journal of Law and Finance, No. 1/2017 Cristina Elena Moldovan authorities in this matter by the consolidating supervisor and they are chaired by the consolidating supervisor10.

2.1. The establishment of the Supervisory Colleges based on Article 51 of Directive 2013/36/EU According to article 51 (1) of Directive 2013/36/EU, the competent authorities of a host Member State may submit a request to the consolidating supervisor or the competent authorities of a home Member State for a branch of an institution to be considered significant. The request shall contain the reasons for which a branch must be considered significant, in particular, the following aspects: a. Whether the market share of the branch in terms of deposits exceeds 2% in the host Member State; b. The likely impact of a suspension or closure of the operations of an institution on systemic liquidity and the payment, clearing and settlement systems in the host Member State; c. The size and the importance of the branch in terms of the number of clients within the context of the banking or financial system of the host Member State. The competent authorities of the home and host Member States and, where Article 112(1) of Directive 2013/36/EU applies, the consolidating supervisor, have the obligation in terms of diligence to do “everything within their power” to reach a joint decision. However, if no joint decision is reached within two months of receipt of the request, while considering any views and reservations of the consolidating supervisor or the competent authorities of the home Member State, the competent authorities of the host Member State shall take their own decision within a further period of two months on whether the branch is significant. The joint decision or the decision of the competent authorities of the host Member State have to be fully reasoned and is determinative and applied by the competent authorities in the Member States concerned, according to para 5 of Article 51 (1) of Directive 2013/36/EU. The establishment and functioning of the college is based on written arrangements determined, after consulting the competent authorities concerned, by the competent authority of the home Member State. Therefore, according to Article 3 (1) (a) and Article 23 (1) (a) of the Delegated Regulation (EU) 2016/9811, after the mapping of the institution with branches in other Member States, the competent authorities of the home Member State invite the competent authorities of the host Member States where significant branches are established to become members of the college. The structure of colleges reflects the activities of the supervised institution. The competent authorities of the home Member State shall communicate to the competent authorities of a host Member State, where a significant branch is established, information on:

Central Bank Journal of Law and Finance, No. 1/2014 141 Supervisory Colleges: Evolving Structures and Diverse Practices. Selected Issues. a. The negative evolutions recorded by institutions or by other entities of a group which can severely affect institutions and significant sanctions and exceptional measures taken by the competent authorities according to Directive 2013/36/EU, including the imposition of a specific own fund requirement under Article 104 of Directive 2013/36/EU and the imposition of any limitation on the use of the Advanced Measurement Approach for the calculation of the own funds requirements under Article 312 (2) of Regulation (EU) 575/2013; b. The results of the risk assessments, mentioned in Article 97 and, where applicable, joint decisions adopted according to Article 113 (2) of Directive 2013/36/EU; c. Decisions adopted within supervisory activities pursuant to Article 104 and 105 of Directive 2013/36/EU to the extent to which these evaluations and decisions are relevant for the concerned branches. In addition, the competent authorities of the home Member State shall carry out the planning and coordination of supervisory activities in cooperation with the competent authorities of the host Member State and shall consult them about the operational steps required by Article 86(11)12, where relevant for liquidity risks in the host Member State's currency. In case the competent authorities of the home Member State have not consulted the competent authorities of the host Member State, or where, following such consultation, the competent authorities of the host Member State maintain that the operational steps are not adequate, the competent authorities of the host Member State may refer the matter to the EBA and request its assistance in accordance with Article 19 of Regulation (EU) 1093/2010. Provisions of Article 51 (3) of Directive 2013/36/EU state that the competent authority of the home Member State shall take into account, when making decisions, the relevance of the supervisory activity which is to be planned or coordinated for the competent authorities of the host Member States, especially by the potential impact on the stability of the financial system in the Member States concerned and by the obligations mentioned in Article 51 (2) of Directive 2013/36/EU. As regards the legal effects of the participation in the College of supervisors of the supervisory authority of the host Member State where the parent credit institution has a branch, the provisions of Article 51 (1) last thesis are applicable, namely that the conclusion of the written cooperation arrangement13 does not prejudice the supervisory tasks of the competent authority from the host Member State, laid down in Title V Chapter 4 and Title VII of Directive 2013/36/EU. In other words, the legal effect is neither a transfer of prerogatives from the national supervisor to the College, nor a segregation of duties between them. In addition, according to Article 10 of the Delegated Regulation (EU) 2016/98 “for the purposes of joint decisions on institution-specific prudential requirements as referred to in Article 113 of Directive 2013/36/EU, the consolidating supervisor and the relevant

142 Central Bank Journal of Law and Finance, No. 1/2017 Cristina Elena Moldovan members of the college referred to in paragraph 1 of that Article shall exchange all information necessary, at both individual and consolidated level, to reach a joint decision”, while the provisions of Article 113 (1) of Directive 2013/36/EU refer to “the consolidating supervisor and the competent authorities responsible for the supervision of subsidiaries of an EU parent institution or an EU parent financial holding company or an EU parent mixed financial holding company in a Member State”. Therefore, given the fact that, in this case, the national supervisory authority only acts as a competent authority in the host Member-State in which there is a significant subsidiary, it cannot be part of a joint decision according to Article 113 of Directive 2013/36/EU.

2.2. The establishment of the Supervisory Colleges based on Article 116 of Directive 2013/36/EU According to Article 116 of Directive 2013/36/EU, the consolidating supervisor shall establish Colleges of supervisors to facilitate the exercise of the tasks referred to in Articles 112, 113 and Article 114(1) of Directive 2013/36/EU and, subject to the EU confidentiality requirements, shall ensure appropriate coordination and cooperation with relevant third- country supervisory authorities where appropriate. The participation of supervisors from third countries is provided for as a general possibility, considering the fact that the EU legislation does not produce mandatory legal effects towards them (their adherence is voluntary). Even when a joint decision is not necessary, the establishment of the College of supervisors remains relevant for the consolidated supervision, especially as far as the exchange of information and emergency planning are concerned.14 Pursuant to Article 116, Colleges of supervisors are a vehicle through which supervisory activities are coordinated, providing a framework for the consolidating supervisor, EBA and other competent authorities concerned to carry out the following tasks: a. exchanging information between each other and with the EBA in accordance with Article 21 of Regulation (EU) 1093/2010; b. agreeing on voluntary entrustment of tasks and voluntary delegation of responsibilities where appropriate; c. determining supervisory examination programmes based on a risk assessment of the group; d. increasing the efficiency of supervision by removing unnecessary duplication of supervisory requirements, including in relation to the information requests referred to in Article 114 and Article 117(3); e. consistently applying the prudential requirements under this Directive and under Regulation (EU) No 575/2013 across all entities within a group of institutions without

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prejudice to the options and discretions available in the Union law; f. applying Article 112(1)(c) considering the work of other forums that may be established in that area. The consolidating supervisor chairs the meetings of the college and decides which competent authorities participate in a meeting or in an activity of the college. Some colleges consist of two authorities only, whereas others comprise 20 or more authorities from all around the world. The frequency and intensity of college activities can also differ significantly depending on the size and complexity of the institutions. Moreover, the consolidating supervisor has the obligation to keep all members fully informed, in advance, of the organisation of such meetings, the main issues to be discussed and the activities to be considered. The decision of the consolidating supervisor shall take account of the relevance of the supervisory activity to be planned or coordinated for those authorities, in particular the potential impact on the stability of the financial system in the Member States concerned as referred to in Article 7 and the obligations referred to in Article 51(2) of Directive 2013/36/EU.

3. JOINT DECISIONS

The consolidating supervisor and the competent authorities responsible for the supervision of subsidiaries of an EU parent institution, an EU parent financial holding company or an EU parent mixed financial holding company in a Member State have the obligation to cooperate effectively (”shall do everything within their power”15) in order to reach a joint decision: a. on the determination of the adequacy of the consolidated level of own funds held by the group of institutions16 with respect to its financial situation and risk profile and the required level of own funds17 for the application of Article 104(1)(a) to each entity within the group of institutions and on a consolidated basis; b. on measures to address any significant matters and material findings relating to liquidity supervision including relating to the adequacy of the organisation and the treatment of risks18 and relating to the need for institution-specific liquidity requirements.19 Regulation No 710/2014 specifies the process of reaching a joint decision on matters referred to in point (a) of Article 113(1) of Directive 2013/36/EU taking account of any waiver granted pursuant to Articles 7, 10 or 15 of Regulation (EU) No 575/2013 and a joint decision on matters referred to in point (b) of Article 113(1) Directive 2013/36/EU, taking account of any waiver granted pursuant to Articles 6, 8 or 10 of Regulation (EU) No

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575/2013, and of any consolidated level of application pursuant to Article 11(3) of that Regulation. The key idea is that, in order to reach a joint decision, it is essential to develop an efficient exchange of appropriate information and, in order to ensure a consistent application of the process for reaching a joint decision, it is important to define every step of the process. The report containing the risk assessment of the group is a core document enabling competent authorities to understand and record the assessment of the overall risk profile of the group for the purpose of reaching a joint decision on the adequacy of own funds and the level of own funds that the group is required to hold, while the report containing the assessment of the liquidity risk profile of the group is an important document enabling competent authorities to understand and record the assessment of the overall liquidity profile of the group. Neither of these two documents should be limited to an aggregation of individual contributions from competent authorities, on the contrary, both reports should be used as a tool for performing the joint assessment of the risks of the whole group and analysing the interaction of intra-group items. The draft group risk assessment report and draft group liquidity risk assessment report is elaborated by the based consolidating supervisor on all of the following: a. Its own SREP report or liquidity risk assessment report on the EU parent institution and the group; b. The SREP reports or liquidity risk assessment reports on subsidiaries provided by the relevant competent authorities; c. Contributions from other competent authorities and competent authorities of third countries. Pursuant to Article 6 of Regulation 710/2010, the consolidating supervisor ensures that the joint assessment reflects the relevance of the institutions within the group and their significance in the local market and that the draft group reports indicate how the relevance and significance were taken into account. Following a dialogue procedure between the relevant competent authorities, the consolidating supervisor finalises the document comprising the joint decision. The joint decisions are set out in documents containing full reasons which shall be provided to the EU parent institution by the consolidating supervisor20. According to Article 113 of Directive 2013/36/EU, joint decisions are acknowledged as determinant and applied by the competent authorities in the Member States concerned.

According to Article 13 of Regulation (EU) 710/201421, the consolidating supervisor shall provide the capital joint decision document and liquidity joint decision document to the management body of the EU parent institution in a timely manner and in any event by the

Central Bank Journal of Law and Finance, No. 1/2014 145 Supervisory Colleges: Evolving Structures and Diverse Practices. Selected Issues. deadline specified in the joint decision timetable. The relevant competent authorities in a Member State provide the management bodies of the institutions which are authorised in that Member State with the respective parts of the joint decision document that are relevant to each of those institutions. The consolidating supervisor shall, where appropriate, discuss the capital joint decision document and liquidity joint decision document with the EU parent institution to explain the details of the decisions and their application. However, Directive 2013/36/EU and Regulation (EU) 710/2014 do not provide for the mandatory legal nature of joint decisions on credit institutions. Hence the question: in order to ensure the implementation of the joint decision at the level of the credit institutions’ subsidiaries from host Member States, is it necessary for the supervisory authority to issue its own act, with mandatory legal force, or is it enough to communicate the joint decision as such? At this point, we underline the basic idea of having a legal ground in the national legislation, through which the measures that are scope of the supervisory policy set by the joint decision can become mandatory for credit institutions, regardless of the fact that the concerned legal dispositions set the legal nature of the joint decision in the host Member State, including for credit institutions, or the legal nature of the documents issued by the supervisory authority. According to some opinions, a joint decision of the supervisory authority in the host Member State is seen as nationally mandatory including for credit institutions. In this case, it would not be necessary for the national supervisory authority to issue a distinct legal document. However, in reality, the supervisory authorities adopting this approach based their legal reasoning on the fact that the national legislation recognizes the administrative decision of a foreign authority, so the administrative decision issued by the foreign authority would be mandatory for credit institutions, according to national legislation. According to other opinions, which we consider preferable, joint decisions represent an agreement between supervisory authorities and they are opposable only as far as the authorities participating in Colleges of supervisors are concerned. To support this approach, we mention the provisions of Article 12 (2) of Regulation (EU) 710/2014: a joint decision has the nature of an agreement between national supervisory authorities as regards the prudential requirements imposed to each credit institution of the group, on consolidated basis. Consequently, the joint decision itself does not generate any legal effects in relation to credit institutions, as third parties in the joint decision/agreement reached by the supervisory authorities. Thus, the capital requirements agreed in a joint decision become effective for the credit institutions only if they are imposed by a supervisory decision of the national supervisory authority, adopted in accordance with the joint decision. As such, joint decisions adopted at the level of the Colleges of supervisors shall be applied by the national supervisory authority through the exercise of the competences provided by

146 Central Bank Journal of Law and Finance, No. 1/2017 Cristina Elena Moldovan the national legislation on prudential supervision, namely by issuing acts with mandatory legal effect in relation to credit institutions. This measure is necessary because the joint decisions adopted by the Colleges of supervisors do not have a mandatory nature, directly applicable to credit institutions. In the absence of such a document regarding the implementation of the joint decision issued by the national supervisory authority, there would not be any legal ground for the application of a sanction to the concerned credit institution. Based on this hypothesis, in the case of Romania, the adoption of prudential measures for the application of the joint decision takes place by taking into account the provisions of Government Emergency Ordinance No. 99/2006 on credit institutions and capital adequacy approved and amended by Law no. 227/2007, as subsequently amended and supplemented, which is the legal framework regulating the prudential supervision of credit institutions and which has transposed, nationally, Directive 2013/36/EU.

According to Article 1827 (2) of Government Emergency Ordinance no. 99/2006, in the case in which the National Bank of Romania does not have the quality of a consolidating supervisor, the joint decisions adopted in the College of supervisors are final and opposable to the National Bank of Romania, which shall apply them accordingly. Further on, Article 233 (2)22 of Government Emergency Ordinance No. 99/2006 stipulates that the documents related to a credit institution, which provide for measures or apply sanctions and sanctioning measures according to this chapter, are issued by the governor, the first deputy governor and the deputy governors of the National Bank of Romania. Consequently, the ground for issuing the document containing the disposition of prudential measures for the implementation of the joint decision is Article 233 (2) of Government Emergency Ordinance No. 99/2006, given the conclusions of the evaluation of the concerned credit institution’s capital, performed during the process of making the joint decision, and the relevant provisions of the Guide on common procedures and methodologies for the supervisory review and evaluation process (SREP)23.

Similarly, according to Directive 2014/59/EU24, resolution authorities should consult each other and cooperate in Resolution colleges when resolving group entities for the purpose of agreeing a group resolution scheme. Resolution colleges are established around the core of the Supervisory Colleges through the inclusion of resolution authorities and the involvement of competent ministries, central banks, the EBA and, where appropriate, authorities responsible for the deposit guarantee schemes. In the event of a crisis, the resolution colleges provide a forum for the exchange of information and the coordination of resolution actions25. In addition, paragraph 98 of the Introduction to Directive 2014/59/EU states that “the resolution college should not be a decision-making body, but a platform facilitating decision-making by national authorities. The joint decisions should be taken by the national authorities concerned”.

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Consequently, Directive 2014/59/EU imposes an obligation regarding the effect: the joint decision between the resolution authorities of various Member States must be enforceable and must be effective nationally. The legal instrument chosen by the Member States for reaching this objective is a national legal matter. The administrative document incorporating the joint decision can be contested in courts from the concerned Member State, according to Article 85 of Directive 2014/59/EU. For the rigor of the opinion supported, in the absence of express legal provisions supporting with certainty one of the two previously mentioned opinions, an informal consultation was initiated at the level of the ECB and of the authorities in the non-euro area regarding the practical approach related to the application of joint decisions. The question was whether the national competent authorities in charge of the supervision of the institutions authorised in a Member State should apply the measures provided in the joint decision by adopting some mandatory national legal acts (for instance, orders, decisions etc.) for the concerned credit institutions. The results of the exercise have revealed that (i) the European Central Bank and the authorities from Poland and Croatia adopt legal documents for the implementation of the joint decision; (ii) The Central Bank of Hungary does not issue their own administrative documents for the implementation of the joint decision, however, it states that, according to the national law, joint decisions “are mandatory and directly applicable in Hungary” and (iii) the Central Bank of Bulgaria does not issue their own administrative documents for the implementation of the joint decision. Apparently, the acceptance of the hypothesis, according to which it is necessary for the national supervisory authority to issue a document in order to ensure the mandatory effect of the joint decision on credit institutions, does not seem to raise operational problems. The issuing these types of acts is included in the parameters of the usual supervision activity. From the procedural point of view, the issuance of a supervisory order (act), be it for the application of a joint decision, should not imply new elements. However, in practice, things can become more complicated when the compliance with the requirements by the credit institution is subject to a deadline and when the communication of the joint decision to the members of the college does not take place in a timely manner. The compliance deadline for the credit institution cannot be previous to the date when the national competent authority issues the order, even if this would imply that the deadline provided by the joint decision is not met. Therefore, the communication of the joint decision must be done so that the supervisory authority’s possibility of adopting the document for implementing the joint decision could be effective. Otherwise, the supervisory authority can find itself in the impossible situation in which it cannot meet the deadline provided for in the joint decision or it adopts a retroactive measure. The circumstance in which the joint decision was communicated too late is not able to remove the aforementioned legal and reputational risks. Consequently, none of the versions is acceptable from the legal standpoint. Thus, the only solution, in this case, would be to modify the initial deadline set by the joint decision.

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4. EVOLVING PRACTICES

4.1. Report of the Peer Review on the Functioning of the Supervisory Colleges In 2010, the CEBS issued a Report of the Peer Review on the Functioning of the Supervisory Colleges, which takes stock of the progress achieved towards a closer cooperation in the supervision of cross-border credit institutions, on the basis of the legal framework in force at the time (i.e. Directive 2006/48/EC, as amended in 2009). In this respect, the Review Panel prepared a questionnaire which was completed, as a self- assessment, by the competent authorities from a sample composed of 17 supervisory colleges, focused on the core activities performed by supervisory colleges, i.e. Information Exchange, Risk Assessment, and Planning and Coordination.

4.1.1. Information Exchange The peer review confirmed that a majority of the colleges (11) applied the requirements in terms of interactivity, level of detail26, frequency, timeliness, scope and means of exchange of information across colleges. Whereas the exchange of information was considered intense during the meetings, the peer review showed that information exchange tended to be more limited in between meetings and that the then supervisors tended to rely on bilateral contacts. In this respect, the Review Panel noted that, while a multilateral and regular exchange of information between the members of the college contributed to effective coordination and cooperation and to the development of a common understanding of the group’s activities and risk profile, the efficiency of information exchange within a college greatly depended on the interaction between all its members. Also, the report mentions that an agreement on a non-exhaustive list of information to be shared within the college would be beneficial for the exchange of information. The Review Panel highlighted the following good practices: a. Web platform; b. Secure e-mails; c. Conference calls; d. Minutes and actions points relating to the core and general college activities and e. Periodic newsletter and templates.

4.1.2. Risk Assessment The Review Panel assessed whether the members of the college share their own assessment with one another and whether the risk assessment was coordinated and discussed in the college. The outcome was that there are significant variations, including as regards the level of detail of the risk assessments. However, a number of good practices were identified:

Central Bank Journal of Law and Finance, No. 1/2014 149 Supervisory Colleges: Evolving Structures and Diverse Practices. Selected Issues. a. Ad hoc meetings of Risk experts groups; b. Joint inspections relating to specific risks and/or ICAAP; c. Use of the CEBS sectoral risk assessment, CEBS stress test, and CEBS liquidity identity card as an element of the risk assessment process; d. A dedicated college meeting or workshop 0n the risk assessment.

4.1.3. Planning and Coordination The Review Panel assessed, in particular, whether supervisory plans were collected, exchanged and discussed in the college, whether joint on-site inspections had been considered and/or carried out by college members and whether a common supervisory plan had been agreed upon. Unsurprisingly, the conclusion was that there was a need for improvement and convergence in this respect and, in particular, the exchange of supervisory plans and common planning needed to be further developed. With regards to planning and coordination, (a) regular updates on supervisory plans and (b) a common reporting for joint on-site inspections were recommended.

4.2. Report on the Functioning of Supervisory Colleges in 2016 In March 2017, the EBA issued its Report on the functioning of supervisory colleges in 2016. The report mentions 136 EEA cross-border banking groups and 76 active supervisory colleges, which were clustered into two distinct groups: 20 closely monitored colleges and 56 colleges with which the EBA staff interacted on specific topics.

4.2.1. Information Exchange The EBA Report (2017) notes that, in 2016, college meetings benefited from “multilateral interactions, in-depth conversations27 and a certain degree of mutual challenging, and, on many occasions, the engagement reached a truly operational level”. It appears that, within almost all of the closely monitored colleges by the EBA in 2016, a dialogue between the consolidating supervisor and the relevant competent authorities was organised in a multilateral setting to discuss and agree upon the proposed capital and liquidity requirements. In terms of the level and quality of the interaction organised within the college framework, of the closely monitored colleges, 90% exceeded the EBA’s expectations on the intensity of college interaction, compared with 74% in 2015. All closely monitored colleges ensured ongoing engagement. However, there still are areas which require further attention, such as the distribution of documents in advance of the meetings, drafting the agenda in order to cover all relevant topics, circulating the agenda for comments and drafting the minutes.

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4.2.2. Group risk assessments and group liquidity risk assessments The EBA´s analysis focused on the assessment of compliance with Regulation (EU) 710/2014, which provides the process of developing and finalising both risk assessments and their main elements as well as the level of convergence in approaches used by the national authorities and the recorded progress in this regard. For 2016, the EBA identified eight topics for supervisory attention stemming from its risk assessment and policy work, namely (1) NPLs and balance sheet cleaning, (2) business model sustainability, (3) operational risk including conduct risk and IT risk, (4) the implementation of SREP guidelines, (5) IRB models (review and cross-border cooperation), (6) the impact of IFRS 9, (7) remuneration (bonus cap) and the EU-wide stress test (home-host cooperation and communication to the market). Taking into account this background, Colleges were expected to consider these topics and discuss the relevant themes for the banking group under their supervision. All colleges discussed four topics directly linked to the risk assessments (i.e. NPLs and balance sheet cleaning, business model sustainability, operational risk and the EU-wide stress test), while other topics related to specific policy products were only addressed to a significantly lower level.

4.2.3. Joint Decisions Regarding the joint decisions on capital and liquidity, the EBA report notes that 75% of colleges reached the final joint decision within the legal timeframe (4 months) and overall, the joint decision documents were well reasoned and contained information on and/or references to the conclusions of the SREP, as reflected in the group risk/liquidity risk assessment reports. However, based on the EBA´s observations, half of the colleges circulated, before the discussions, draft documents which did not include proposals for quantitative and qualitative requirements for the group and for some entities within the group. Consequently, during the meetings, the interaction focused on noting quantitative and qualitative requirements, instead of meaningful in-depth discussions. Host authorities and the EBA raised their objections to this approach to the consolidating supervisor in various colleges in order to ensure reciprocity on the timing of sharing the proposed quantitative and qualitative measures between college members. Furthermore, The EBA report notes that, in general, the liquidity joint decisions were of a lower quality than the capital joint decisions’ one, mainly because of their less granular reasoning, particularly in the case of subsidiaries, because of the lack of consistency in the structure of the annexes or the weak connection between the reasoning in the liquidity joint decision document and the group liquidity risk assessment.

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With respect to the Joint decisions on the assessment of group recovery plans and other EBA work in this area, 2016 was noted as a year of transition and it is not yet possible to draw a clear conclusion on the integration of individual entities into the group recovery plans. The analysis of the elements included in the CEBS report (2010) as compared to the EBA report (2017) and their content shows that the evolution was the shift of the emphasis on the establishment of the cooperation mechanism named ”Supervisory College” – that is the process (which is observed in the increasing number of colleges), towards the efficient collaboration within existing Colleges – that is the content items (which is observed through the operational issues they encounter).

5. CONCLUDING REMARKS

Over the last years, Supervisory colleges have received considerable attention both in the regulatory field and supervisory debates. Strengthening the supervision of cross-border banking groups requires a holistic supervisory approach which can only be achieved through consistent exchange of information, common understanding and agreement between supervisors. Supervisory colleges serve as a tool and platform for reaching common agreement regarding the requirements on capital, liquidity and recovery planning. Coordination and cooperation within Supervisory colleges represent an evolutionary process, which involves joint responsibility and allocation of resources on behalf of both the competent authorities and the EBA and considering the reference set of documents and reports, it is clear that the Colleges have made significant progress in performing their tasks. However, our analysis shows that one of the weaknesses in the mentioned evolutionary process is the fact that Colleges are not autonomous decision-making bodies, which, from a legal point of view, reveals a remaining strong connection to the national law. The national legal regime, the manner to perform the supervisory tasks, the instruments and the legal grounds for issuing supervisory acts by the authority stand applicable. It is clear that the joint decisions reached within the Colleges shall be recognized as determinative and applied by the competent authorities in the Member States concerned. However, the practical approach related to the application of joint decisions is not uniform among supervisors. While most supervisors of the institutions authorised in a Member State apply the measures provided in the joint decision by adopting a mandatory legal act for the concerned credit institutions, in some jurisdictions (considerably fewer) it is considered that a separate legal act is not needed.

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In terms of challenges to be addressed, it is noted that the Colleges´ activity does not include the macro-prudential dimension and the involvement in resolution plans is reduced (resolution colleges). Also, while performing with the purpose to develop uniform practices, it is a fact that the Colleges bring together participants from Member States with different supervisory models (eg "twin-peaks" model vs. sectoral model) and variables that have a conceptual effect on the regulatory framework. Against this background, although a faster pace may appear feasible, an effective approach for an effective framework would be to consolidate current achievements rather that an en mache continuation of the integrative process.

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NOTES

1 CEBS’ Guidelines for the Operational Functioning of Supervisory Colleges (GL 34), 15 June 2010. 2 CEBS’ Guidelines for the joint assessment of the elements covered by the supervisory review and evaluation process (SREP) and the joint decision regarding the capital adequacy of cross- border groups (GL39), 22 December 2010. 3 Principles for effective supervisory colleges, Basel Committee on Banking Supervision, July 2014, page 8. 4 CEBS’ Guidelines for the Operational Functioning of Supervisory Colleges (GL 34), 15 June 2010, para 2; 5 Regulation (EU) No 1093/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Banking Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/78/EC (O.J. L331, 15 December 2010, p. 1). 6 Article 3 (3) of the Commission Implementing Regulation (EU) 2016/99 of 16 October 2015 laying down implementing technical standards with regard to determining the operational functioning of the colleges of supervisors according to Directive 2013/36/EU of the European Parliament and of the Council O.J. L21/21 of 28 January 2016. 7 The Colleges of supervisors are provided for by the legal framework in the recovery resolution field as well. According to the Bank Recovery and Resolution Directive – BRRD, colleges shall assess the recovery plans of cross-borders banks and adopt a joint decision regarding the assessment of these plans. Within the BRRD framework, recovery planning on an individual basis applies only to stand-alone institutions, i.e. entities not belonging to groups. For group entities, recovery plans shall be developed for the group as a whole. According to Article 8(2) of the BRRD, a joint decision between the consolidating supervisor and the competent authorities of subsidiaries shall be reached on ‘whether a recovery plan on an individual basis should be drawn up for institutions that are part of the group’. Thus, the option to have an individual recovery plan for a group entity is not excluded by the BRRD, but this should be the outcome of a joint decision. 8 Directive 2009/111/EC of the European Parliament and of the Council of 16 September 2009 amending Directives 2006/48/EC, 2006/49/EC and 2007/64/EC as regards banks affiliated to central institutions, certain own funds items, large exposures, supervisory arrangements, and crisis management, O.J. L302/97 of 17 November 2009. 9 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC, OJ L176/338 of 27 June 2013. 10 Articles 115 and 116 of Directive 2013/36/EU. 11 Commission Delegated Regulation (EU) 2016/98 of 16 October 2015 supplementing Directive 2013/36/EU of the European Parliament and of the Council with regard to regulatory technical standards for specifying the general conditions for the functioning of colleges of supervisors O.J. L21/2 of 28 January 2016. 12 Article 86(11) of Directive 2013/36/EU: ,,Competent authorities shall ensure that institutions have in place liquidity recovery plans setting out adequate strategies and proper implementation measures in order to address possible liquidity shortfalls, including in relation to branches established in another Member State. Competent authorities shall ensure that those plans are tested by the institutions at least annually, updated on the basis of the outcome

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of the alternative scenarios set out in paragraph 8, reported to and approved by senior management, so that internal policies and processes can be adjusted accordingly. Institutions shall take the necessary operational steps in advance to ensure that liquidity recovery plans can be implemented immediately. For credit institutions, such operational steps shall include holding collateral immediately available for central bank funding. This includes holding collateral, where necessary, in the currency of another Member State, or in the currency of a third country to which the credit institution has exposures, and where operationally necessary within the territory of a host Member State or of a third country to whose currency it is exposed.” 13 According to the EBA, in 2015 more than 50% of Colleges did not finalise their written coordination and cooperation arrangements and only a college finalised it in 2016. 14 Single Rulebook Q&A, 2015_2460. 15 Article 113 and Article 116 (1) of Directive 2013/36/EU 16 For the implementation of articles 73 and 97 of Directive 2013/36/EU on capital adequacy assessment 17 According to article 104 (1)(a) of Directive 2013/36/EU, competent authorities may require credit institutions to hold own funds in excess of the requirements set out in Chapter 4 of this Title and in Regulation (EU) No 575/2013 relating to elements of risks and risks not covered by Article 1 of that Regulation. 18 As provided for by article 86 of Directive 2013/36/EU on liquidity risk. 19 According to article 105 of Directive 2013/36/EU on specific liquidity requirements. 20 Article 113 of Directive 2013/36/EU. 21 Commission Implementing Regulation (EU) No 710/2014 of 23 June 2014 laying down implementing technical standards with regard to conditions of application of the joint decision process for institution-specific prudential requirements according to Directive 2013/36/EU of the European Parliament and of the Council, O.J. L188/19, 27 June 2014. 22 Article 233 (2) of Government Emergency Ordinance No 99/2006: ”The documents establishing the measures and the penalties laid down in this Chapter shall be issued by the Governor, the First Deputy Governor or Deputy Governors of the National Bank of Romania, except for the measures referred to in Article 226 para. (2) let. g) and the penalties referred to in Article 229 para. (1) let. d) and e), the imposition of which falls within the scope of the National Bank of Romania Board”. 23 EBA/GL/2014/13, 19 December 2014. 24 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council (text with EEA relevance), O.J. L173/190 of 12 June 2014. 25 Para. 96, Introduction, Directive 2014/59/EU 26 Only one out of 17 colleges participating in the peer review had formally discussed the distinction between ”essential” and ”relevant” information; see CEBS’ Report of the Peer Review on the Functioning of the Supervisory Colleges , para. 74; p. 16. 27 All closely monitored colleges received a ”good” score for this criterion, compared with 2015 when 22% were assigned a ”satisfactory” score, see EBA Report, para. 48, p.17.

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REFERENCES

1. Bank for International Settlements, Basel Committee on Banking Supervision, Principles for home-host supervisory cooperation and allocation mechanisms in the context of Advanced Measurement Approaches (AMA), November 2017 2. Bank for International Settlements, Basel Committee on Banking Supervision, Principles for effective supervisory colleges, June 2014. 3. Bank for International Settlements, Basel Committee on Banking Supervision, Progress report on the implementation of principles for effective supervisory colleges, July 2015 4. European Banking Authority, Report on the functioning of supervisory colleges in 2016, 22 March 2017 5. Committee of European Banking Supervisors, Report of the Peer Review on the Functioning of 6. Supervisory Colleges, 18 October 2010 7. Committee of European Banking Supervisors, Guidelines for the Operational Functioning of Supervisory Colleges (GL 34), 15 June 2010; 8. ***, Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC, JO L176/338, 27 June 2013 9. ***, Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 10. ***, Directive 2009/111/EC of the European Parliament and of the Council of 16 September 2009 amending Directives 2006/48/EC, 2006/49/EC and 2007/64/EC as regards banks affiliated to central institutions, certain own funds items, large exposures, supervisory arrangements, and crisis management, OJ L302/97, 17 November 2009 11. ***, Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council, OJ L173/190, 12 June 2014. 12. ***, Commission Implementing Regulation (EU) 2016/99 of 16 October 2015 laying down implementing technical standards with regard to determining the operational functioning of the colleges of supervisors according to Directive 2013/36/EU of the European Parliament and of the Council, OJ L21/21, 28 January 2016 13. ***, Commission Delegated Regulation (EU) 2016/98 of 16 October 2015 supplementing Directive 2013/36/EU of the European Parliament and of the Council

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with regard to regulatory technical standards for specifying the general conditions for the functioning of colleges of supervisors, OJ L21/2, 28 January 2016. 14. ***, Commission Implementing Regulation (EU) No 710/2014 of 23 June 2014 laying down implementing technical standards with regard to conditions of application of the joint decision process for institution-specific prudential requirements according to Directive 2013/36/EU of the European Parliament and of the Council, O.J. L188/19, 27 June 2014.

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