Graham Bishop/Paula Martín
Organised by the Centre for the Study of Financial Innovation (CSFI) with co-presenterHans Hack (FTI Consulting)
This blog covers the key subjects since our last meeting that I hoped to cover but, as always, we ran out of time to deal with them all. As a Friend, you can watch the 28th `structured’ CPD web-cast with CISI. These Notes may be read to record a further 30 minutes of `structured CPD’, including a dipping into the links to the underlying stories.
Highlights from the “Brussels for Breakfast” meeting
“471 days until we go over the cliff” again dominated the discussion – unsurprisingly in the light of the agreement that the Brexit negotiations have made “sufficient progress”. The full implications of DEXEU Secretary Davis’ subsequent comments on this agreement not being “binding” proved contentious but the EU reactions is key: first sort out a transition (or is it a prolongation?) and only then move to discuss the trade deal in March. Given the lags in the EU’s legislative process, and possible Treaty ratifications, it is easy to see that the trade deal needs to be struck by the autumn – giving credibility to Barnier’s comment that there will only be time to do a deal similar to the Canada CETA trade agreement. For the City, this would be deeply unsatisfactory as the “prudential carve-out” may create a very bad outcome.
However, the same analysis of the legislative process underlined that time is running out for new legislative initiatives as the shadow of the April 2019 dissolution of the Parliament and October termination of the Commission is now darkening the outlook. That makes the comprehensive Commission proposal on Completing EMU all the more surprising – especially in the absence of a German Government.
However, that should not detract from the potential progress on many parts of the November 2016 Banking Package of Risk Reduction Measures. Progress is now underway with ECON reports on CRD and CRR proposals, and the Presidency is attempting to create a Council consensus. However, the key discussion focussed on the issue of NPLs – heavily reflecting the travails of Italy. The mechanics of the “expected losses” thrown up by IFRS9 coming into force yet the losses being public information - correctly – but only progressively reflected in regulatory capital bemused participants. But that should not obscure the real progress on the ECB’s push for quick recognition of “new” NPLs and possibly a platform or European “asset management company” to trigger a genuine market.
In the spirit of CPD, we finished by discussing Governor Carney’s speech on two years of the Fair and Effective Markets Review which included comments on the FSB’s “misconduct action plan”. An initial fruit of this is the ESCB’s statements of commitment to the FX global code but the lawyers present argued that unless banks actually incorporate the code in their contractual `Ts and Cs’, it would not be enforceable in UK courts – so what is the point?
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Key issues of the rest of the month included:
Theresa May might have received a very special Christmas present that will throw her a lifeline to survive politically to 2017: the long overdue declaration by the Commission that ‘sufficient progress’ has been achieved and a – not likely, after being ruled out by member countries angered by Davis’ remarks that the draft guidelines are ‘not binding’- swift start of the hardest and most ardently wanted part – trade and transitional arrangements talks. The Prime Minister is clinging on the hope that EU leaders will finally approve the guidelines drafted by the Council President on the base of May and Juncker’s joint report on Friday,15th
Talks came to a head at the beginning of last week with Brussels, London and Dublin agreeing on the guidelines for avoiding a hard border between Northern Ireland and the rest of the island but – little detail – as May forgot to consult the Irish Unionists who prop up her Government, which thwarted a likely agreement. It looks like David Davis’ recognition that “you don’t need to know that much” to conduct the talks in which the UK and the bloc part ways after 40 years of British membership is not correct after all – a smattering of negotiating skills would have spared the ‘Brexit team’ a big squabble with the DUP and among Conservative MPs over Ireland and the financial settlement.
Multiple phone calls overnight on Thursday the 7th and an early flight to Brussels on Friday made the final trick and the British PM got a close call nearly on the deadline – an initial recommendation for the Council to concede talks to move on to the second phase, the hardest of them, for which lawmakers “only have ten months left to determine the transition period and our future relations with the UK”, Tusk reminded.
But the UK is still not out of the woods, the top EU Brexit broker warned: “even if the European Council does recognise sufficient progress on Friday,” Michel Barnier said, “we will have a final agreement only if […] the Joint Report is translated into legally binding and precise language for the Withdrawal Agreement.” A sober reminder for May after her statement to the UK Parliament that the agreed ‘Brexit bill’ was to be conditioned to a good trade deal, and for Davis after his saying that the agreement was more a “declaration of intent” that a “binding agreement”.
Not a promising beginning after more than a year and a half of toil and big headlines, and a half-hearted applause at home for May – 61% of voters now think that the Government is handling the negotiations badly, who will have to confront her political foes within her own Cabinet and a Europhile revolt in Parliament upping the pressure on her to give MPs a vote on the final Brexit deal – over half of voters want to have a say too on it and back a second referendum.
The UK’s European Union Committee warned against the leap in the dark that a no-deal Brexit would be – this is the most undesired outcome, the report conceded, but “concluding all aspects of the negotiations before March 2019” will be “impossible”. Furthermore, MPs urged the Government to ensure that a viable custom system will be in place at Brexit to avoid a ‘catastrophic’ situation.
Not only business are claiming a transitional deal to phase-in the new rules after Brexit: The Bank of France Governor Francois Villeroy de Galhau urged the UK and European Union to move to avoid the consequences of an abrupt separation and said that “super-systemic” operations for clearing of the euro-denominated derivatives should be moved from London after Brexit to “where the supervision of the Euro-system can be exercised effectively.”
Although relocation plans by the ECB are finding resistance across the bloc because of governments’ reluctance to accept a more centralised supervision of euro-clearing, the process might be effectively on the move: The Economist reported that Eurex’s clearing division said that so far around 20 banks had joined a “partnership programme” to boost the volume of assets being cleared by the firm. ,
The British banking sector proved to be “resilient to deep simultaneous recessions in the UK and global economies”, according to the Bank of England’s stress tests, but a no-deal, no-transition Brexit would entail a major potential disruption in cross-border contracts, the head of the UK Financial Conduct Authority told MPs, and this possibility is also real for insurance policyholders on either side of the Channel. The message from ECB official Sabine Lautenschlägeradvising banks to “be prepared” for Brexit because “no one will wait for you” seems to have struck a chord among bank executives, that have removed €350bn of UK-related assets from their balance sheets since the Brexit vote and might have also taken note of experts at KPMG warning that the EBA headquarters’ shift to Paris will reduce the UK’s influence over financial regulation.
Although the UK Government is still ambiguous over what kind of FTA it wants and how it plans to achieve it, Brexit Secretary David Davis gave a strong hint, saying that the UK wants to secure a post-Brexit free-trade deal with no tariffs – that he described as "Canada plus plus plus" - and if negotiators fail to secure it, then the UK would not pay its divorce bill. But a British CETA – without any ‘plus’ – may be the best the UK can hope for in trade after divorce from the EU, in Jean-Claude Piris assessment. Davis’ demands for a bespoke trade deal with the best of all the FTAs the EU has with Canada or Japan are raising eyebrows among EEA partners: Norway’s EU minister warned that “any transitional arrangement that extends the application of the single market in the UK for a time-limited period after withdrawal should also include the EEA states.”
Banking Union
The European Commission and ECB’s President Mario Draghi welcomed the final endorsement of the Basel III reforms framework, a new set of rules that Stefan Ingves, the chair of the Basel Committee, said will “help reduce excessive variability in risk-weighted assets and will improve the comparability and transparency of banks' risk-based capital ratios”. Brussels keeps transposing Basel III into European law - the European Parliament released a draft report on the proposal of the Parliament and the Council for amendingthe CRR and the CRD IV.
But concerns around the imbalances that some features of the revamped capital requirements may cause to EU banks remain: Analysis provided by the EBA showed that the minimum required capital (MRC) of EU banks would increase by 12.9% in weighted average terms.
The EBF warned against the consequences of the introduction of the output floor – a measure that limits the extent to which European banks can calculate how risky their lending can be according to their own models - and called for a rigorous impact assessment of the measure on the industry. The latest EBA assessment of the consistency of risk weighted assets (RWAs) across all EU institutions authorised to use internal approaches for the calculation of capital requirements confirmed previous findings, with the majority of risk-weights (RWs) variability explained by fundamentals.
The biggest UK banks, largely reliant on foreign capital, teamed up with their Swiss and Japanese peers to caution lawmakers overseeing the consultation over the so-called intermediate parent undertakings (IPUs) in what is set to be the biggest row over Basel IV agreement between London and Brussels before Brexit. IPUs – a rule that forces foreign banks to raise the capital and liquidity set aside in case their European subsidiaries collapse – might force international companies out of Europe, the signers of the letter warned.
Basel IV won’t be the only new set of rules to pose a challenge to European banks next year: the IFRS 9 international accounting standard will be phased-in in January thanks to transitional arrangements approved by the Council that will try to soften the regulatory capital impact in the EU. The European Parliament provisionally approved a transitional regime that will dilute the effect of new rules governing the valuations of financial assets. The EBA published its final methodology for the 2018 EU-wide stress test that, for the first time, incorporated IFRS 9 accounting standards. Alexander Lehmann at Bruegel dissected the economics of the new standard and wrote that the rules “should encourage the disposal of banks’ distressed assets, underpinning the ongoing agenda on NPLs”.
Non-Performing Loans are one of the main challenges European financial firms face - in spite of a more resilient banking sector - the EBA’s latest report on risks and vulnerabilities found. In order to deal with this major burden, the European Central Bank released draft guidance that sets out how ECB expects banks to provision for future NPLs, and its upcoming Financial Stability Review showed that the problem can be overcome with transaction platforms that would also require structural changes aimed at expanding the investor base.
EBA observed good progress in implementation of SREP Guidelines in its third annual Report on the convergence of supervisory practices across the EU.
An improved European economy has given EU leaders the determination to move forward towards deepening EMU, and the completion of the banking union is one of the biggest projects lawmakers should focus on in 2018, according to Council President Donald Tusk during the latest European Council. It remains unfinished business and, if not pushed ahead, it could fall backwards and fail, researchers at Bruegel found. CEPS’ Stefano Micossi proposed guidelines for rounding the banking union out, whereas analysis carried out at VoxEU focused on the concentrated exposure of banks to their own sovereign and LSE’s Helen Louri made the case for a ‘fourth pillar’ of the banking union in the shape of a pan-European asset management company that could help tackle non-performing loans.
The ECB’s Mersch praised the second EU Payment Services Directive and urged banks to “implement instant payments as soon as possible” – Mersch said that the combination of both will offer new business opportunities and provide citizens with a real-time safe payment experience. The EBF noted that the Commission adopted its regulatory and technical standards for PSD2, but warned that the rules still face obstacles. In the UK, users of Open Banking system – the British version of the Directive – will not allow one of the customer data transfer measures, called “screen scraping”. The Parliament released a briefing supporting ECON’s work on its scrutiny of delegated acts under PSD2. The European Payments Council informed that the SEPA Instant Credit Transfer (SCT Inst) scheme is now operational.
Capital Markets Union
With only three weeks left until the entry into force of the revised standard on markets and financial instruments (MiFID), the rules keep stirring European lawmakers’ concerns: ESMA wrote to the European Commission calling into question the entire MiFID II third-country regime. Its analysis of this important strand – even more topical because of Brexit - “indicates that there might be circumstances where firms located in the EU would be subject to more stringent requirements than firms located outside the EU.” Investment professionals may have noted the difficulties already, with as much as 78% of them expecting to source less research from external providers after MiFID II is implemented in January, according to a survey by the CFA Institute. AFME and IA published an updated Equities Electronic Trading Questionnaire ready for MiFID II. ESMA updated its MiFID II Q&A on market structure issues and on MiFID II/MiFIR Investor Protection topics and clarified the application of the trading obligation for shares to trade certain instruments on-venue. ESMA Executive Director Verena Ross spoke about the work carried out by ESMA in the context of third country frameworks and of the implications of the EU regulation on Asian firms.
TheMarkets in Financial Instruments Regulation has raised some concerns too: ISDA, AFME and GFXD sent a letter to ESMA laying out some key outstanding uncertainties in the MiFIR post-trade transparency framework for investment firms from an over-the-counter derivatives perspective.
The Council adopted new securitisation rulesas part of the EU’s plan to develop a fully functioning capital markets union by the end of 2019. Yves Mersch, Member of the Executive Board of the ECB, outlined how STS Regulation could make an important contribution to the revival of the securitisation market and the establishment of a CMU in Europe.
AFME welcomed the European Commission consultation on post trade in a CMU anda report by Expert Group on European Corporate Bond Markets for which itreviewed the functioning of the European corporate bond markets, in the context of building a Capital Markets Union. It also published a new report highlighting the significant impact that key elements of the Commission’s Risk Reduction Measures legislative package could have on Europe’s capital markets and the wider economy.
In light of the upcoming British withdrawal from the EU, European lawmakers and thinktanks analysed the consequences for central counterparties, given the huge amount of euro-derivatives that are cleared daily in The City of London. Commenting on the proposed EMIR revisions, CEPS CEO Karel Lanoo argues that the “Commission should have assessed risk management with CCPs in more detail and should have proposed a more integrated architecture for the supervision and resolution of CCPs,” because the current structure is “very incoherent.” Mersch backed strengthening the role played by the EU's central banks of issue in the regulatory framework, as the authorities responsible for the implementation of monetary policy. Authors at VoxEU highlighted the need for a CCP to monitor the pool of ultimate investors in cleared contracts. ISDA and AFME issued a Briefing Note onSA-CCR, a methodology to calculate the capital required to address the risk that the counterparty to a derivative contract will not live up to its contractual obligations, is a replacement for two existing ‘simple’ and outdated non-modelled exposure methods – CEM and SM.
ESMA’s Chairman Steven Maijoor identified key principle workstreams for ESMA for 2018 and referred to the recent ESMA opinions regarding continental relocation of UK firms in connection with Brexit. Maijoor reaffirmed ESMA’s view that these were consistent with the level 1 and level 2 texts, as it is “precisely in the nature of Level 3 guidance to take the existing framework and elaborate on it, in order to give a clearer picture of what firms are expected to do in order to comply.”
IOSCO published a report on the implementation of the G20/FSB post-crisis recommendations aimed at strengthening securities markets, while ESMA published its final report on Money Market Funds rules.
Economic
The European Commission launched a policy package that sets a specific roadmap for putting in motion further important steps for the deepening of Europe's Economic and Monetary Union such as the Banking Union, the Capital Markets Union or a European Monetary Fund. Eurogroup President Jeroen Dijsselbloem reported on the results of the Eurogroup meeting and said that the agreed “agenda would have to be broadened: it is not just about the banking union, but also about fiscal issues and the role of the ESM,” and that he expects decisions on first steps by June next year. Guntram Wolff at Bruegel writes that “instead of creating an ill-designed European finance minister role, the European Commission should propose to make the Eurogroup president a full-time position with a clear European mandate.”
ECB President Mario Draghi discussed the outlook for the euro area economy and said that “boosting the resilience of the EMU implies also reinforcing our common institutional set-up so as to prevent and manage shocks.” The European Council agreed a list of 17 tax heavens, among which none of them is located within the bloc.
Financial Services Policy
The European Commission followed up on its stock-taking exercise of financial regulation with a new report on its Call for Evidence on EU financial services.
IOSCO issued a report on the global hedge fund industry and the potential systemic risks this industry may pose to the international financial system.
Julia Hoggett, Director of Market Oversight at the FCA, reported on the implementation of the Market Abuse Regulation in the UK.The Joint Committee of ESAs published draft technical standards specifying how credit and financial institutions should manage money laundering and terrorist financing risks at group level where they have branches or majority-owned subsidiaries based in third countries, while ESMA updated its Questions & Answers document regarding the implementation of the Market Abuse Regulation.
Clients Union
Financial institutions and companies are increasingly becoming aware of the need of complying with international regulation regarding good practises: 15 of the ESCB central banks, including the ECB, committed to the Foreign Exchange Global Code of Conduct, while the Bank of England Governor, Mark Carney,said the City “has a special responsibility to address the root causes of misconduct given its pre-eminent position in global markets.”
The EU’s forthcoming General Data Protection Regulation (GDPR) is a major piece of legislation that UK risk managers will have to obey despite Brexit. The EBF commented on data breach notification under the Working Party guidelines for the GDPR.
Insurance
The European Insurance and Occupational Pensions Authority announced that in the next three years, one of its key priorities is to further enhance supervisory convergence, with the aim to move towards a common European supervisory culture. EIOPA published results analysing trends in the investment behaviour of European insurers over the past 5 years and identified a search-for-yield trend.
The Financial Stability Board, in consultation with the International Association of Insurance Supervisors and national authorities, decided not to publish a new list of global systemically important insurers (G-SIIs) for 2017.
The Governor of the Bank of France, François Villeroy de Galhau, cited institutional innovation, economic innovation and technological innovation as the main drivers of evolution in insurance and pensions. Risk managers and insurers are beginning to understand the potential transformational benefits of blockchain for the industry. However, the introduction of the technology is still a long way off as many issues still need solving, according to currency experts and asset managers.
Corporate Governance
The Chair of the IASB, Hans Hoogervorst, said that the central theme of the IASB’s current work plan is Better Communication in Financial Reporting.
The IPSASB published a revised IPSAS with amendments that address some of the main barriers to adoption of this standard. ACCA examined IPSAS implementation and found that it has started to provide significant and common advantages across the public sector.
The FRC published proposals for a revised UK Corporate Governance Code that is shorter and sharper, and builds on the findings from the FRC’s Culture Report published in 2016.