By Graham Bishop/Paula Martín Camargo
Organised by the Centre for the Study of Financial Innovation (CSFI) with co-presenterMark Simpson (Baker McKenzie). 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 29th `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
We are now down to 401 days until we go over the Brexit cliff and the UK feels no nearer to laying out the details of what it wants. Perhaps this week’s Cabinet away day will finally reach conclusions but speeches from the Foreign Secretary and DexEU minister provided little clarity – especially after 62 MPs wrote to the Prime Minister setting out their own red lines.
For the financial services industry, the deadline for action is drawing perilously near. But what action? The volume of calls from across the Channel to get on with applications for banking licences grows louder with comments that only a handful of licence have been issued. But it seems that many are under discussion and what about firms that simply want to extend their existing activities? Nonetheless, it was accepted that there would be capacity constraints among EU regulators if there is a last minute rush.
The precise mechanics of changing contracts generated fierce discussion: would the EU and UK just agree a legal text that makes the conversion? Or would clients have to agree contract by contract… and when would the agreed changeover date be? And what would happen if suddenly there is a transition of some unknown length? Many questions!
On the mainland, the economic and monetary “guard” is changing: the Eurogroup President and President of the Euro Working Group went off uneventfully and with continuity, but the ECB Vice- Presidency was rather different. A `southern’ serving finance minister with limited experience of monetary policy was catapulted into the job. What does that mean for the big job of ECB President? The favourite remains a `northerner’ and BuBa President Weidman is clear favourite - ahead of Banque de France’s Villeroy de Galhau.
In the technicalities, we discussed the impact of IFRS9 disclosure guidelines. As banks are required to publish expected losses with and without the permitted smoothing, we were at a loss to understand why bondholders would do anything except look at the full impact. But a cynical – and seasoned – participant suggested it may have more to do with profits that drive executive remuneration…
Naturally, MiFID II was a topic – focusing at this stage on the impact on research. The feeling was clear that a major reduction – even of worthwhile research - was inevitable. SBBS were discussed and I expressed the view that the ESRB report may be the end of the road… but a “safe asset” for banks remains essential – as does a “risk free” euro interest rate to serve as a benchmark. My plan for a Temporary Eurobill Fund could meet both needs.
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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 foundations for the second phase of the Brexit talks have proven not to be very solid. Inspired by UK’s Brexit Secretary David Davis’ motto that “nothing is agreed until everything is agreed”, the top EU Article 50 negotiator Michel Barnier warned British officials against their backtracking in “substantial” agreed principles and flagged the risk for the UK of crashing out of the EU without a transition period in case that the deals achieved weren’t rapidly transposed into law – a major concern for MEPs. The UK Prime Minister has found battle lines in all fronts, with MPs at home calling for more reforms to her Withdrawal Bill. Theresa May faces also distrust among business, with more than two-thirds of companies not confident in Government's ability to negotiate with the EU.
Under the negotiating directives for transitional arrangements adopted in January’s Council meeting and published by the Commission, Britain will be bound by EU laws but have no say over them, a friction point that May’s administration has tried to fight and that could threaten transition talks. The EU’s stance in this regard might have activated the ‘hard Brexit’ option: senior officials told POLITICO that the British PM plans for an ‘immediate’ break with the EU in trade or financial services after withdrawal, which has raised the EU27’s fears of a ‘bonfire of regulations’ that could undermine the bloc’s economy after divorce and resulted in the publishing of a strategy paper that threatens with sanctions in case of a regulatory ‘race to the bottom.’ Dispute settlement remains a key sticking point for the future trade deal, a Commission’s internal document suggested: a feasible option could be ‘docking’ with the European Free Trade Association (EFTA) Court as a dispute resolution body, wrote POLITICO’s Georgina Wright.
Brexit is starting to bite into the whole European economy and might cost dearly: it will hit economically almost every sector and every UK region and will do so in every scenario, according to official impact assessments seen by BuzzFeed News, which also disclosed that London could lose its preeminent place in financial services, with the possibilities available under an FTA not much different to those in the WTO option. Withdrawal from the EU could cost Scottish economy £16bn a year and the hardest of Brexits could cut more that €5.5 billion from the Irish Treasury over the next two years, according to governmental estimates. As for the EU, a Guardian analysis claimed that a No-deal Brexit would cost the EU economy £100bn.
It is high time for the UK to make a choice on Brexit trade future, reminded Michel Barnier, who warned that future trade barriers will be “unavoidable” if the UK chooses to leave the bloc’s customs union. If London presses ahead with its plan to abandon the EU’s single market and customs union, the two-year transition proposed by the UK will be ‘practically impossible’ to achieve,Ireland’s junior finance minister warned - not to mention Brussels’ aim to reduce by three months that period and disconnect from London on 31 December 2020. Northern Ireland leaving the customs union is becoming an increasingly indissoluble issue, with a secret EU plan for keeping the British territory inside the customs union triggering a row between May’s Tories and Scotland.
The messages around what Britain actually wants have been governed by disparity: Cabinet ministers who backed Remain are urging Theresa May to seek a “Norway-style” deal to help fill a looming €15bn hole in its budget – a model that could be also in the EU’s budgetary interests to fill in the Brexit-size hole in the future EU budget; while a “technical note” prepared by the British government called on non-EU nations to treat the UK during its transition period as if it was still covered by the more than 700 treaties Brussels has struck with third countries over its entire membership.This won’t be as impossible as replicating the EU’s free trade agreements for March 30th 2019, CER’s Sam Lowe wrote. Perhaps acknowledging this crude reality, Chancellor Hammond made a dramatic call for a soft Brexit that involved “very modest” changes to the UK’s relationship with the EU. A Free Trade Deal would see EU migration falling by just 40,000 a year, a leaked impact assessment suggested – and UK’s immigration system may still be unprepared for Brexit.
David Davis’ claim for "mutual recognition" in standards will be met with relief among British business: Business groups told the FT that a large majority of companies want to maintain regulatory alignment with the EU. But before the UK goes on with its ‘full regulatory alignment’ claims, it must clarify how it will be able to leave the EU’s customs union, pursue its own trading arrangements with other countries, and yet avoid the creation of a hard Irish border, wrote the LSE’s Anthony Costello.
British banks are running out of time to guarantee access to the European Union’s single market after Brexit, the ECB’s Supervisory Board official Sabine Lautenschläger warned. They should make sure they’re prepared for the possibility that the UK and the EU were unable to agree on a transition deal post-Brexit, ECB's President Mario Draghi said.
Despite Michel Barnier’s warning that ousting the single market would mean losing access to passporting rights, the Bank of England’s chief banking regulator said a Brexit trade deal including the City is possible, and could be completed in three years. The statement was countered by minutes of a EU27 meeting ruling out including financial services in a future trade deal, the FT learned from confidential discussions that revealed a tough line towards the City of London, in the belief that shrinking its global sway would be beneficial for the bloc. However, research by UK in a Changing Europe found that financial services is one of the least vulnerable sectors to Brexit as much of the sector is not very dependent on EU markets.
Either way, the financial services industry needs clarity on post-Brexit market access, the EU Financial Affairs Sub-Committee said following an inquiry in which Graham Bishop took part as a Witness. The report highlights some of the potential cliff edge risks that Brexit could create for market efficiency and financial stability that have been stressed by a recent AFME paper.
The Chancellor of the Exchequer, Phillip Hammond, needs to stop warning about the risks of financial instability and find a way out of the glass house he is occupying, wrote Stewart Fleming, with Graham Bishop arguing that “a breakdown in Brexit talks on the future of the City’s role as a centre for euro currency financial services business will certainly be damaging banks on both sides of the channel. “But it will be the British economy which will suffer worse,” Bishop warned.
Perhaps one of the sectors that could be harmed the most would be asset management, with the EU writing to the fund managers to urge them to act now or face potential market shutout when the UK has been extricated from the EU. The EU27 plan a massive shake-up of AM delegation rules, a move that may become the “number one issue” of concern for UK and global asset managers and could find British asset managers an ally in US regulators and lobby groups, which are stepping up their resistance to restriction of access to the single market to third countries . Changing delegation rules post Brexit could cause wider fragmentation in financial markets and raise costs, a Bank of England top official warned.
Insurance will be affected as well by the British departure, and Insurance Europe published two papers to avoid market disruption for insurance consumers, in which it calls for a transitional arrangement and relates to the transfer of personal data between the EU/EEA and the UK post-Brexit.
Brexit cracks Europe’s capital markets union, wrote Fiona Maxwell, suggesting that Brussels let the UK retain a role post Brexit. The Deutsche Bundesbank illustrated the pragmatic approaches to a "no deal" on financial services.
The flood of bad news in all fronts related to the Article 50 negotiations has increased popular support for a second referendum to rethink Brexit with 16 points margin over Leavers and created a roots movement that is calling on lawmakers to demand a second vote that would be won by 55% Remainers. Voters aren’t deaf to the European leaders’ calls: EU chief executive Jean-Claude Juncker renewed an offer to Britain to stay in the European Union, while Council President Donald Tuskreminded British voters that they could still reverse their decision to leave. The former President of the European Council Herman Van Rompuy told VRT News that “sooner or later” the United Kingdom will re-join the EU. In case the UK voters changed their mind and decided to halt Brexit, Andrew Duff assessed the terms and conditions would apply to the UK's renewed membership. The Fed Trust director Brendan Donnelly also thinks there will be and should be another referendum before Britain leaves the European Union.
The plan for a pan-European constituency that would pick up 46 of the 73 of the empty seats left by British officials in the European Parliament after Brexit was rejected by a large majority. The Parliament’s size will be therefore reduced from 751 to 705 elected representatives from the different EU member states.
Economic
The European Systemic Risk Board (ESRB) published its long-awaited reports on Sovereign Bond Backed Securities (SBBS), an idea that was brewed in 2011 by the consequences of the Great Financial Crash and that consists in creating a new class of “safe assets” through a securitisation of euro area government bonds. They are a great idea, but they fall behind in tackling the much wider problematic picture that a Temporary Eurobill Fund (TEF) would seek solutions to, as Graham Bishop assessed.
The arguments, eloquently addressed in a recent EU Vox paper that proposes six reforms– three of them were subject of reflection by Graham Bishop-, go from a safe asset; to direct contribution to financial stability; as well as global scale issues of great liquidity; flexible and progressive market discipline to enhance economic governance; or a genuine fusion of euro area citizens’ economic interests into a `European asset’ that can be a core savings instrument for all.
The European Union recorded a 2.5% GDP growth over 2017, growing at its fastest pace in 10 years and giving EU regulators the grounds for starting to put an end to economic stimulus measures: the ECB joined central bankers in most developed economies that expressed confidence over the global economic recovery, and indicated it will cut its QE programme faster than previously estimated. But the eurozone is still not “shock resilient,” outgoing Eurogroup chief Jeroen Dijsselbloem told the FT in a departing warning, hinting at further reforms in Greece and other European countries to finally leaving the financial crisis’ effects behind.
The ECB's Cœuréoutlined the three requirements than any euro area reform will have to pass: flexible markets reflected in a true capital markets union and banking union; building adequate national fiscal buffers that can absorb large shocks and prevent destabilisation; and a fiscal instrument that goes beyond the ESM and is able to help the euro area cope with this kind of shocks without having to rely too heavily on the ECB. The latter argument served to remind Germany that it would have to increase efforts for risk-sharing across the euro area to prevent the risk that the ECB would need to take more extraordinary monetary policy action – frowned upon in Germany – in case that a new international financial crisis strikes.
In the FT's view, the key to unlocking the impasse is a common deposit insurance scheme that shores up bank deposits with an insurance scheme funded by all European banks . This might be disapproved by risk-reducers like Germany, that argue that, before any form of risk-sharing can take place, risk reduction has to be ‘complete’ – but an agreement on deposit insurance could prove a meaningful step forward towards minimising the European divide between risk sharers and risk reducers in Europe.
During January’s ECOFIN, EU finance ministers removed eight countries from the bloc’s tax haven blacklist, and discussed non-performing loans and the programme of the Bulgarian presidency. The Eurogroup reached a political agreement on the third review of Greece's economic adjustment programme and debated further steps towards deepening the Economic and Monetary Union. The European Parliament published its annual report on Public Finances in EMU 2017.
Banking
The ongoing works to lessen remaining risks in the European banking sector seem to be bearing fruit, as the Commission’s First Progress Report on the tackling of non-performing loans to support the risk-reduction agenda showed:The overall NPL ratio in the EU was cut down to 4.6%, which confirms that risk reduction is taking hold among EU banks, and will support progress towards completing Banking Union.
The EBA Risk Dashboard underpinned these results, but warned that key challenges such as major impediments to the resolution of NPLs - lengthy and expensive judiciary processes and the lack of liquidity in secondary NPL markets - and profitability remain. The market for distressed debt will need to play a more prominent role in Europe’s emerging strategy to tackle the legacy of non-performing loans (NPLs) by speeding up resolution and allowing greater flexibility in bank balance sheet management, wrote Alexander Lehmann.
The EBA launched its 2018 stress test of European banks and released the macroeconomic scenarios, among which the adverse scenario implies a deviation of EU GDP from its baseline level by 8.3% in 2020, resulting in the most severe scenario to date. The Banking Federation underlined its full commitment to the process and reminded that this year’s exercise is to be performed at a crucial moment when banks are migrating towards the new IFRS 9 accounting standard.
The accounting rules entered into application on the first day of 2018 and regulators are seeking to phase-in their impact: the EBA published its final Guidelines on disclosure requirements of IFRS 9 transitional arrangements to analyse the effect of the impairment requirements included in IFRS 9 on capital and leverage ratios, whereas EFRAG reported on the assessment of the impact of the new model on long-term investments in equity instruments.
The efforts to consolidate a more stable global banking system that prevents the sweeping effects of the latest financial meltdown are still met by investors’ reluctance to raise requirements that may result in bigger costs: ECB's Sabine Lautenschläger called on banks and other stakeholders not to try to water down the agreed Basel III measures, while BIS chairman Stefan Ingves reminded that work remains to implement Basel III nationally in a full, timely and consistent manner. Analysis at VoxEU found thatthese standards are implemented differently from jurisdiction to jurisdiction in the EU banking sector, which widely explains the differences in risk weight variability among banks.
Resolution was also topical, with Bruegel reporting on this essential pillar of the EU’s banking union: the think tank acknowledged that, in spite of the Single Resolution Board shortcomings so far, improvements recently made to the tool might prove the usefulness and ultimate success of the SRB. But, as the ECB’s Mersch warned, “liquidity provision by central banks in the event of resolution must not be assumed ex ante,” and “funding gaps that cannot be addressed by the industry or through the Single Resolution Fund should be filled, ultimately, by Member States.” The Banking Federation supported the approach provided by the Financial Stability Board in its consultation on Funding Strategy Elements of an Implementable Resolution Plan, which aims at operationalising funding within the resolution planning.
The revised Payment Services Directive (PSD2) started applying as of 13 January. The package seeks to promote the development of innovative online and mobile payments. The rules ban surcharges for consumer debit and credit card payments, which could save more than €550 million per year for EU consumers. The EPC launched a public consultation on the Mobile Contactless SEPA Card Payments Implementation Interoperability Guidelines (MCP IIGs), while
BPCE, a major French cooperative banking group, became the very first payment service provider (PSP) in France to adhere to the SEPA Instant Credit Transfer (SCT Inst) scheme.
The wild volatility of Bitcoin and the frenzy around Virtual Currencies have led the ESAs to warn consumers of the risks in buying virtual currencies. Regulators said VCs are highly risky and unregulated products and are unsuitable as investment, savings or retirement planning products. The European Central Bank called on legislators to “pay close attention to mitigating the potential risks that could stem from growing VC business.” But smaller European banks have smelled a “big opportunity” and some of them - such as Swiss Vontobel and Falcon Bank or Germany’s Fidor Bank and Liechtenstein’s Bank Frick - have given investors access to cryptocurrencies and advising on initial coin offerings.
Capital Markets Union
CEPS’s Karel Lanoo warned that MiFID II will profoundly affect the portfolio management business, making the brokerage market more competitive and maybe even requiring banks to separate from their asset management business. The new rules are having a sweeping impact that could be extended beyond Europe: Nomura was the first leading bank to publicly indicate that it is considering restructuring as a consequence of MiFID II’s requirement to disclose the costs of research for investors.
The controversial measure has sparked mounting concerns that the revamped rules will result in waning research coverage normally supplied by brokers to SMEs: The FT reported that European stock exchanges such as Euronext and Deutsche Börse are exploring ways to support their smaller companies, helping them make themselves more readily available to investors.
European regulators kept issuing documents to cushion the implementation of MiFID II rules: AFME released a note addressing issues in connection with the investor education process when pre-deal research is produced by independent financial analysts in the research departments of firms, while ESMA updated its transitional transparency calculations for equity and tick sizes under the renewed Markets in Financial Instruments Directive as well as its Q&A document on transparency and market structures, and published the responses received to its consultation on proposed amendment to MiFID II RTS 1.
Ensuring that MiFID II and MiFIR are applied in a sound, efficient and consistent manner across the EU and maintaining supervisory convergence during the UK’s withdrawal from the EU, as well as monitoring the impacts of Brexit on the third country CCP regime, were highlighted as the main priorities of the financial watchdog for 2018 in ESMA’s documents setting out its supervisory activities for CRAs, TRs and TC-CCPs in the EU and its Supervisory Convergence Work Programme for the new year.
The Securities and Market Authority published the responses received to its Consultation on position calculation under the European Market Infrastructures Regulation and an update of its EMIR Q&A on practical questions, along with an update of its Questions and Answers regarding the implementation of the Central Securities Depository Regulation.
The European Central Bank , together with ESMA, the European Commission and the Financial Services and Markets Authority (FSMA), announced the composition of the working group on euro risk-free rates, which will work on identifying and recommending this alternative to the current benchmarks used in a variety of financial instruments and contracts in the euro area, and on studying potential issues in relation to transition to these rates. ISDA, AFME, ICMA and SIFMA launched a roadmap that highlights key challenges involved in transitioning financial market contracts and practices from IBORs, to alternative risk-free rates.
ICMA published a report on the European repo market at year end 2017 that identifies several possible reasons for the 2017 year end being less disorderly than 2016.
Clients Union
With just under three months remaining until the General Data Protection Regulation (GDPR) comes into effect, regulators across Europe released implementation guidance to secure smooth and effective compliance: AIMA issued its GDPR Implementation Guide, while ICAS showed how it will provide support in this area, Accountancy Europe published a post to help SMEs get their practice GDPR proof, and the Financial Conduct Authority (FCA) together with the Information Commissioner's Office (ICO) published an update on GDPR.
Insurance Europe called on the data protection guidelines not to overreach the GDPR on its draft guidelines on transparency and on the consent needed to process people’s data under the GDPR.
Asset Management
Insurance Europe published the industry’s key priorities and recommendations that policymakers must address to ensure the Pan-European Pension Product is a success, among which it said that PEPP must be a real, long-term pension product to address the pension gap.EFAMA endorsed an independent study that concluded that the inclusion of life-cycle investment strategies as default option in the PEPP is economically desirable for consumers over a long investment horizon.
The European Commission launched a survey to assist with a study into how the AIFMD has worked in practice and to what extent the Directive's objectives have been met.
ESMA said regulators stand ready to provide “additional guidance” related to the new packaged retail investment and insurance-based products (PRIIPs) set of rules after the publication of wildly misleading performance projections by some product providers, which might have ‘misinterpreted’ a new obligation to publish performance forecasts.
The FCA’s Andrew Bailey explained in the FT why regulators have fund managers in their sights: the British financial watchdog’s asset management market study will propose this spring major changes to the rules that govern the industry, after its assessment found weak price competition in many areas, sustained high profits at companies, a lack of clarity over what funds are seeking to achieve and their performance, and fund boards that lack independence and do not fully consider whether the fund is achieving value for investors’ money.
Insurance
Insurance Europe welcomed the proposal to delay the date of application of the Insurance Distribution Directive (IDD) and accompanying delegated legislations - the application date was postponed to 1 October 2018 to allow the insurance industry to better prepare for the directive.
In its response to EIOPA’s draft advice to the European Commission on its 2018 review of Solvency II, Insurance Europe said the document must focus far more on areas mandated by the Commission.
EIOPA published the first paper of a series on systemic risk and macroprudential policy in the insurance sector. One of the biggest assets that can help ensure financial stability and encourage long-term investments are the latest IFRS Accounting Standards, according to the IASB, which issued two reports on the impact of IFRS 9 and IFRS 17 on the financial sector, as well as the materials and other support available for implementation and a simple one-page summary of the IFRS 17 accounting model to help stakeholders understand different elements of the model and how they will be displayed.
In the years to come, IFRS 17 - the first insurance accounting standard - will be a challenging milestone and “the most significant change to insurance accounting that has ever taken place and the latest of many pressures facing insurance CFOs,” Aptitude Software’s CTO Martin Redington warned. The company published a Global IFRS 17 Readiness Assessment (GIRA) report which shows that 92% of companies have yet to put their IFRS 17 solutions in place.
The UK’s Treasury announced that the British misconduct regime will be extended to insurers’ senior managers and as part of the UK government’s plans to extend the senior managers and certification regime.