10 April 2018

Less than a year for an increasingly unlikely Brexit - 140th Brussels for Breakfast – CPD Notes

Highlights from the “Brussels for Breakfast” meeting

Now only 353 days until we go over the “cliff” – so the 150^th B4B may mark the end of the UK’s EU membership! A lengthy Brexit discussion was inevitable and we focussed on the shape of the deal on the future of EU-UK trade relations, rather than the Withdrawal Agreement or Transition Deal. The seven pages of Guidelines were agreed by the EU27 Heads of Government as part of the Article 50 Council meeting but seem to have had little coverage in the UK – despite their huge significance.

The European Council has now agreed the dates for the next European Parliament elections in May 2019 so the final plenary session of the Parliament will be early April 2019. Any legislative proposals not agreed at that stage are at risk of having to re-start – especially if the new Commissioner on financial services decides to follow precedent and initiate a lengthy review. So the practical deadline for any new legislative proposals is close - May 2018.

Karel Lanoo at CEPS has published a report on the dangers of forcibly moving euro derivatives clearing out of London and splitting regulation away from the single oversight of the Bank of England. He is probably right that the existing proposals would fragment control and raise risks. But could another answer be to centralise it under say ESMA?

Progress on tackling NPLs generated much discussion. The Commission has proposed a four-pronged action package to deal with the stocks of existing NPLs. But there is also pressure to prevent new NPLs appearing – IFRS9 will be a disincentive but the ECB – in the shape of the SSM – has also proposed regulatory measures and the EBA is advising the Commission on the use of prudential backstops.

The issue of benchmarks re-surfaced as the ECB has launched a second consultation on replacing Euribor and ISDA is urging market players to get engaged.  The FCA will cease to compel/persuade banks to submit LIBOR observations after 2021 and it seems that floating rate bonds may well become “fixed rate at the last-published fix” if no solution is found.

We had an enlightening discussion on the recent work of the International Forum of Independent Audit Regulators (IFIAR) – the `IOSCO of audit’. After all the post crisis work on strengthening audit, IFIAR has reported lapses in 40% of the 918 risky/complex situations audits tested last year. Disturbingly, the most common lapse was insufficient challenge of the reasonableness of assumptions. The second was insufficient challenge of management data/reports. What then is the point of an audit?

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These Notes for the Friends of Graham Bishop will be supplemented by our full Workbook for our CPD clients (link) – in conjunction with the 30-minute CISI webcast. We our “CPD Weekly – 10 Minute Read ‘n Verify” (link) complies with ESMA Guidelines

Key items of the rest of the month

The 29^th March 2018 marked the start of the countdown for Brexit day. If everything proceeds as planned, the UK will leave the European Union in a year and a 21-month transition period will be triggered. But the official terms of this period and of the future EU-UK relationship are yet unknown – Graham Bishop argued that, when clearer arrangements emerge from negotiations this summer, the same voters that took the decision to leave might well decide that the economic and political implications Brexit entails aren’t as beneficial to them as they first thought, and that they’d like to have a say over them.

Moreover, polling by BritainThinks revealed that there is widespread support among Leavers and Remainers for a vote on the final deal. Bishop concluded that this makes all the more likely that, in the end, Brexit won’t happen at all.

The crystallisation among public opinion and MPs of the idea that Parliament can’t just let May’s cabinet pass the final Brexit deal and passively await the departure day without scrutiny seems to have madeLabour’s Sir Keir Starmer declare that his party is still hopeful of being able to vote down, in alliance with other Parliamentary parties and a handful of Conservative rebels, to any bill on the terms for Brexit that the Prime Minister May will put to the House of Commons in the autumn.

MEPs and officials in Brussels are perplexed at the bickering in London over the Brexit terms that keeps producing ‘red lines’ but not a coherent, unified idea of what kind of future relationship the UK wants.   All this “wishful Brexiting”, as Jérôme Gazzano and Andi Mustafaj at the Fondation Robert Schuman have named the impossible Brexit the UK is suggesting, is forcing the EU to take the initiative of the effective definition of the transition period, and by this, the UK is losing the very initiative of it.

Authors argue that negotiators at Brussels are essentially integrating the British red lines and turning them into a legally acceptable position, which was evident in the European Parliament’s resolution that recommended an association agreement for future EU-UK relations.   Speaking in Parliament, the  EU’s Brexit negotiator Michel Barnier urged Britain to face the “hard facts” of Brexit: the UK cannot have the “status of a third country and at the same time want the advantages of the union,” including unfettered access to the single market without accepting the EU oversight of its rules – a blow to the UK’s hopes of securing the crucial “mutual recognition” of its regulatory standards.

The European Council took into account those “repeatedly stated positions of the UK, which limit the depth of a future partnership” in its March 23^rd guidelines on the framework for post-Brexit relations with the UK, in which it confirmed that trade talks could begin. The document nonetheless warned the UK that “being outside the Customs Union and the Single Market will inevitably lead to frictions in trade” and “unfortunately will have negative economic consequences, in particular in the United Kingdom.”

May’s Brexit team will have a hard time combining Brussels’ guidelines with the high expectations at home: the Commons’ overarching inquiry into the Article 50 negotiations’ third report set out the “key tests by which any deal agreed by October 2018 must be judged,” among which financial services would continue to operate seamlessly across the EU as if nothing had changed.  But the report’s aspirations aren’t likely to be met: experts at the UK Trade Policy Observatory analysed the possibility of a bespoke Canada trade deal for Britain and foundthat“the EU’s commitment to the Single Market is so deeply ingrained” that a sweetheart deal for the UK  would be politically impossible.

Financial services’ industry is deeply concerned that the EU won’t let British banks twist its arm over post-Brexit access: Bloomberg reported that the EU will consider offering the UK “improved equivalence” for its financial services, a very precarious position crafted with studied ambiguous language that will make Britain dependent on the EU’s financial institutions criteria on the equivalence of the EU and UK’s rules. The Bank of England’s latest update on its regulatory approach to preparations for EU withdrawal considered that it would be business as usual for banks during the so-called “implementation period”, and that they may plan on the assumption that UK authorisation or recognition will only be needed by the end of the implementation period. But banks aren’t convinced for their EU operations: so far, about 20 banks have decided to expand their presence in Frankfurt in preparation for Brexit, according to the Association of Foreign Banks in Germany, creating 5,000 jobs that will be spread more throughout the bloc once Britain has left.

One of the most sensitive financial issues is the lucrative business of clearing of derivatives in euro, and Brussels’s plan to shift the entire sector within the EU may threaten financial stability, in the opinion of CEPS think-tank CEO Karel Lanoo. Lanoo argues in the FT that splitting supervision of euro clearing between ESMA, the ECB and national authorities after Brexit may be disruptive for the industry, cause fragmentation and uncertainty and create tensions with the US, which operates under the same third-country system that would apply to the UK post-withdrawal. The impact for UK-based asset managers will be high as well, with the focus on delegation rules. ESMA’s Chair Maijoor warned that “financial centres in the EU27 should be free to compete based on the particular strengths they can offer relocating firms, like speed and efficiency, but in all cases the EU rulebook should be consistently applied.”

Graham Bishop recently illustrated the radically different targets of his proposed Temporary Eurobill Fund that go far beyond the limited objectives of the Commission plan for a Sovereign Bond Backed Securities framework. Bishop analysed the four specific objections to SBBS by the debt managers, as well as their comments on “safe assets”.  

Banking Union

The European Commission presented measures to accelerate the reduction of non-performing loans in the banking sector, along with its second progress report on the reduction of NPLs in Europe that shows that the decline of NPL stocks is continuing. The package sets out a mix of complementary policy actions that target four key areas: ensuring that banks set aside funds to cover the risks of loans becoming non-performing in the future; encouraging the development of secondary markets; facilitating debt recovery; and assisting Member States that so wish in the creation of Asset Management Companies.

Commission Vice-President Dombrovskis urged Member States to complete works on the November 2016 banking package since the banking package is a “key deliverable for risk reduction in [European] banking sector,” according to the Roadmap to completing the Banking Union.

The EBA issued an advice for the European Commission on the use of prudential backstops to prevent the building up of new NPLs and launched a consultation on how to manage non-performing exposures and forborne exposures, while the ECB published the addendum to its Guidance to banks on non-performing loans (NPLs) and called for input on the detailed features of the new unsecured overnight interest rate.

The Basel Committee proposed revisions to minimum capital requirements for market riskand published a frequently asked questions document on market risk capital requirements. The Committee released for consultation a technical amendment on the regulatory treatment of accounting provisions of the Pillar 3 disclosure requirements.   It also issued frequently asked questions on the Basel III standardised approach for measuring counterparty credit risk exposures.

The Financial Stability Board, which gained prominence a decade ago in the efforts to avert the financial fault lines that caused the global crash, has decided to “pivot away” from making policy recommendations to the G20and  assess the efficiency and possible unintended impacts of its regulations. The letter by the FSB Chair Mark Carney, ahead of a summit in Argentina, comes at a time in which new threats such as crypto currencies are emerging, although Carney dismissed the risk they posed to financial stability because of them being “small relative to the financial system”. The G20 meeting of finance ministers and central bank governors deferred getting virtual coins “under the regulatory tent” to the Financial Stability Board to study the topic more and report back in July.  The Board published supplementary guidance to its principles and standards on sound compensation practices.  

The EBA reported on the functioning of supervisory colleges in 2017, concluding that significant improvements have been achieved over the last couple of years in college interactions, responsiveness, and in the quality, coverage and reasoning of the joint decision documents.

The European Commission proposed rules to make cross-border payments in euro cheaper across the entire EU. The rules will remove costs for non-euro area residents or businesses if they carry out euro transactions with an euro area Member State.  

The ECB's Benoît Cœuré presented the Euro Cyber Resilience Board for pan-European Financial Infrastructures, a forum that seeks to enhance the cyber resilience of financial market infrastructures and their critical service providers, as well as that of the wider EU financial sector, in line with international standards. Cœuré announced that the Eurosystem is putting the finishing touches to the main elements of the European Threat Intelligence-Based Ethical Red-Teaming (TIBER-EU) Framework.  

Capital Markets Union

Vice-President Dombrovskis presented the Commission strategy to accelerate work and complete the Capital Markets Union by 2019. New proposals include common EU rules to boost covered bonds as a source of long-term finance; measures to boost the cross-border market for investment funds; and to facilitate cross-border transactions by providing legal certainty on who owns a claim. Dombrovskis urged EU institutions to help the Commission make the CMU plan “past the finish line” before the next European elections.

The Commission published its Action Plan on Sustainable Finance, a roadmap to a more conscious financial system that is part of the Capital Markets Union's efforts to connect finance with the specific needs of the European economy to the benefit of the planet.

The introduction of MiFID II has been mild so far.  ESMA's Chair Steve Maijoorsaid he believes that “the changes to cost transparency introduced by [MiFID II and PRIIPs] are already having a positive impact.” But the most visible effect at this stage has been increased costs to fund managers due to mandatory disclosure of research fees, while Institutions grapple with rules around carve-outs and inducements, writes Hannah Murphy in the FT. The big questions for managers include: what constitutes 'research', and how do you assess the value of its content?   

Asset managers are setting aside tens of millions of dollars after almost all big investment houses decided to shoulder the cost of research following the introduction MiFID II. While the industry expected costs to amount yearly as much as 10 basis points of the assets under management, early estimates value the outlay to be significantly smaller.  

European securities markets, infrastructures and investors remain at risk, the European Securities and Markets Authority said in its latest Trends, Risks, and Vulnerabilities (TRV) Report.   ESMA published the responses received to its Consultation on draft RTS under the new Prospectus Regulation, among which SMSG Advice said that the review of the Prospectusrulesshould result in an increased level of investor protection and a true reduction of costs for issuers.  

Big banks such as JPMorgan, Bank of America and Citi are developing a new platform to streamline the dislocated bond issuance process , in a push to consolidate their control of the lucrative underwriting business that is currently a leading driver of bank revenues and has become increasingly important since the financial crisis.   

Economists at the IMF analysed current resolution tools for central counterparties (CCPs) in the context of policy, which is to restore the critical functions of a failed CCP, and concluded that the toolkit is insufficient to avoid the costs of resolution being borne by taxpayers. ESMA issued the responses received to its Consultation on Draft Guidelines on Anti-Procyclicality Margin Measures for CCPs .  

The EBF responded to the EBA consultation on the homogeneity of underlying exposures in securitisation highlighting that well established securitisations considered as high–quality under current market practices must be preserved and considered as simple, transparent and standardised under the new securitisation framework.  

In the drive for benchmark reform, ISDA is leading the effort to reduce the reliance on certain key IBORs and to adopt RFRs in their place. This has become a major priority for the derivatives industry and for policy-makers due to concerns about the robustness and viability of certain IBORs amid a lack of underlying transactions in the unsecured bank funding market.   

Clients Union

The FT welcomed an initiative by the Banking Standards Board (BSB), a private-sector body that published a statement of principles that challenges firms to make a strategic commitment to strengthening professionalism across their organisations and aims ultimately to restore the trust of the people in banks as well as to dignify a sector whose reputation was shredded during the 2007 financial crunch.

UK regulators have already taken an important step by establishing a senior managers and certification regime, authors recognise, but it’s about time that the industry sets up specific standards to that end. The FCA keeps working along these lines and published a discussion paper on transforming culture in financial services.  

However, much is still needed to tackle ethical issues: the International Forum of Independent Audit Regulators identified serious problems at 40% of the audits they inspected last year, raising concerns about the quality of auditing process being carried out by the biggest accounting firms. Furthermore, 41% of the problems identified by audit regulators last year related to independence and ethics.   

Insurance

The Council has delayed the application of new rules on insurance distribution to 1 October 2018. The directive also extends to 1 July 2018 the deadline given to member states to transpose the new rules into domestic law.

Insurance Europe published an insight briefing on the upcoming Solvency II reviews, ahead of a European Commission hearing on changes to the regulatory framework. The suggestions include reducing the cost of capital in the risk margin, and the reduction of capital requirements for long-term investment in equity beyond unlisted equity.  

Asset Management

The Commission’s legislative proposals on facilitating cross-border distribution of investment funds drew frosty reactions: EFAMA warned that a legislative proposal to amend the AIFM and UCITS Directives at this stage can act as an additional barrier rather than facilitating cross border fund distribution, whereas ALFI noted that the Proposal could have been given greater scope and effectiveness in particular with regards to the notions of marketing and pre-marketing which have not been extended beyond the AIFM Directive context.