Higher Interest Rates, A Volatile Crypto-Asset Environment and the Growth of Opaque Non-Bank Institutions Challenge Central Banks and Regulators in the EU.
These were the opening remarks of Dr. David Doyle, an EU financial services regulatory expert, and frequent speaker at A-Team Group conferences, when we met up with him early in the New Year to talk about the imminent EU regulatory priorities.
Developments in the EU regulatory agenda going into 2023 are being pursued against a background of bleak economic prospects, David noted, “with most of Europe poised to go into the Bermuda Triangle of recession, higher unemployment and relentless inflation”. The ECB is poised to potentially increase Eurozone interest rates by a 50 basis points when the agency meets on 2nd February, on the back of a 2.5% hike of its benchmark interest rate over 2022 – “adding to higher borrowing costs by European households and affecting government bond yields, and creating yield curve inversions”.As the New Year dawns, David sees, however, evidence of slightly improved EU economic performance, citing Eurozone inflation falling back to 9.2% in December, after annual price growth exceeding 10 percent for the previous two months, and European gas prices stabilising at levels last seen before Russia’s invasion of Ukraine in late February 2022.
While the crypto-asset sector was rocked by a number of high-profile failures, the EU is forging ahead with the most comprehensive global legislative package designed to replace national bespoke regimes with an all-embracing Markets in Crypto-Assets Regulation, covering crypto issuers, providers, exchanges, trading platforms, custodian wallet providers, brokers etc. “The EU is pretty much setting the benchmark for the rest of the world in terms of regulating the crypto-asset space, including actors from outside the EU, but operating across the 27EU”.
What’s lacking, says David, is a holistic and harmonised approach to regulating crypto-assets on a transnational scale, which is grounded in the principle of “same activity, same risk, same regulation”. “To reiterate the recent FSB orthodoxy on the subject, where crypto-assets and intermediaries perform an equivalent economic function to one performed by instruments and intermediaries of the traditional financial sector, they should be subject to equivalent regulation”.
The non-banking institutional space is also ripe for intensified attention by all regulators, predicts David, with such intermediaries share of the total financial systems assets now accounting for just under 50% of the global financial system in 2021, compared to 42% in 2008.
These challenges have not prevented the EU Institutions from actively working on a number of prioritised areas for legislative action in 2023, and David identifies these as including:
Sustainability risks disclosure regime.
The Corporate Sustainability Reporting Directive, to be implemented in 2024 (reports published in 2025) for listed companies with over 500 employees and disclosing sustainability information across the entity’s financial value chain. In addition, the EU Sustainable Finance Disclosure Regulation (SFDR) will require all financial actors to manage the sustainability risks of their own activities and measure how they impact the environment and society (double materiality’ approach). A complementary Taxonomy Delegated Act was approved in 2022 proposing the inclusion, under certain conditions, of specific nuclear and gas energy activities in the list of environmentally sustainable economic activities covered by the EU taxonomy.
New EU anti-money laundering authority.
The AMLA becomes operational in 2025 with direct supervisory powers over the
40 ‘riskiest’ financial sector firms with cross-border operations. The preliminary focus will be in overseeing certain critical ‘obliged entities’ across the 27EU to include credit institutions, bureaux de change, UCITs firms, credit providers other than credit institutions, e-money institutions, investment firms, payments service providers, life insurance undertakings, life insurance intermediaries, and crypto-asset service providers
Revisions to MiFID, UCITS, AIFMD
The key amendments being negotiated are : common rules on AIFM and UCITS liquidity management tools, common rules for AIFMs managing loan-originating, creation of a Consolidated Tape as a centralised database of market date on price and volume of securities traded across EU trading platforms, the reduction of the double volume cap (DVC) for dark trading from 8% to 7%. The new measures also remove the venue-specific 4% DVC, aligning the Derivatives Trading and Derivatives Clearing Obligations for smaller entities, resulting in suspension of central clearing and trade reporting, and abolishing ‘Open Access’ rule, allowing buyers and sellers of derivatives listed on exchanges across the EU to choose where they clear their contract.
David remarked that, “somewhat reassuringly, the 3rd country investment firms use of the delegation model by AIFMs and UCITS managers’ vis-à-vis 3rd countries, for risk and portfolio management tasks, will continue to be permitted”. However, 3rd country investment firms will be subject to more prescriptive disclosures required to NCAs:
- List & description of delegated functions/activities
- Information about delegates and AIFM/UCITM due diligence over delegates, performance, sub-delegation,
- Amount and percentage of assets delegated on portfolio management
Management companies are also required to hire minimum of 2 persons on full-time basis and be resident in the EU
EC strategic autonomy
The EU will continue to explore measures to reduce the ‘over-reliance’ on non-EU financial institutions in the EU financial services environment, which will include strengthening EU derivatives’ clearing CCPs, reducing risk via dollar-denominated transactions, exposures to foreign exchange swap markets.
Specifically, the EU will continue to develop a stronger and deeper Economic and Monetary Union, including the completion of the Banking Union and further developing the Capital Markets Union, as a key component to building a stronger “domestic” market, and a prerequisite for the EU and its currency to compete globally.
In parallel, the EU pursues the development of measures to shield its financial sector and critical financial-market infrastructure vis-à-vis non-EU actors. This relates to infrastructure which is indispensable for the functioning of the financial system: stock exchanges, banks, central counterparties, central securities depositories etc.
More recent measures announced by the EC to scale-up EU’s Capital Markets Union included):
- Making EU clearing services more attractive and resilient, supporting the EU’s open strategic autonomy and preserving financial stability.
- Harmonising certain corporate insolvency rules across the EU, rendering them more efficient and helping promote cross-border investment.
- Alleviating administrative burdens associated with a new Listing Act for companies of all sizes, in particular SMEs, so that they can better access public funding by listing on stock exchanges.
David noted that a combination of inadequate institutional capacity and liquidity, the original ambition to shifting a greater proportion of Euro-denominated derivatives clearing to the 27EU from its traditional London CCP base may now be implemented in a more gradual and managed fashion rather than in a ‘big bang’ fashion. The EC had set a temporary equivalence measure allowing EU counterparties to use UK clearing houses until June 30, 2025,
In December 2022, the EC amended EMIR for firms subject to the clearing obligation which will be required to clear at least a portion of certain systemic derivatives through active accounts at EU CCPs. The specific derivatives concerned by this amendment embrace:
- Interest rate derivatives denominated in euro and Polish zloty
- Credit default swaps
- Short-term interest rate derivatives denominated in euro
The requirement to clear such specific derivatives in an EU CCP will be met via accounts opened directly at an EU CCP or indirectly through a clearing member, depending on the clearing arrangements in place, with further specified regulatory technical standards.
Another important legislative change being finalized at EU Parliament and Council level is the introduction of a new third-country bank branch regime to replace a somewhat laissez-faire licensing and supervisory framework operated by national competent authorities, with divergent practices.
The EC will integrate provisions on 3rd country banks (TCBs) into Basel III (CRD6/CRR3), covering a harmonized authorization, capital, liquidity, governance, reporting & supervision framework. In short, all TCBs will subject to a (re) authorization requirement, and including an NCA ‘national option’ allowing them to impose more stringent market access rules. This could, in exceptional cases, predicts David, result in a requirement to subsidiarize.
The new regime, expected to come into place in 2025, will require 3rd country banks to establish a branch and apply for an authorization to provide ‘core banking services’ in a single Member State, especially when providing services dealing with retail clients in that jurisdiction. This will be accompanied by a prohibition to provide cross-border services into the EU from a third country (expect on a reverse solicitation basis)
A branch will henceforth be required by non-EU banks seeking to operate in individual EU Member States, limiting the branches to activities in the EU jurisdiction of incorporation and banning cross-border service provisions, for most ‘core bank services’, as follows:
- Taking deposits and other repayable funds.
- Lending including, inter alia: consumer credit, credit agreements relating to immovable property, factoring, with or without recourse, financing of commercial transactions, financial leasing.
- Lending to EU corporations only possible via a TCB or a subsidiary in the EU, and not directly from 3rd country bank based in a 3rd
- Payment services, and issuing and administering other means of payment: i.e., travellers’ cheques and bankers’ drafts
- Guarantees and commitments
- Credit reference services
- Safe custody services
- Issuing electronic money.
For more details about a new series of regulatory update events soon to be launched by A-Team Group entitled Insider’s View from Brussels – a deep dive into Financial Tech Regulations, delivered by David Doyle, please complete the form below to obtain registration conditions.
A leading EU financial services regulatory expert based between Brussels and Paris, David Doyle, will provide quarterly deep-dive updates into the latest Fintech and related financial services legislative developments covering EMIR, MiFIR, AIFMD, the EU Digital Strategy, the new EU AML framework, the sustainability disclosure regime, the revised Capital Requirements Directive/regulation, amongst other topics.
The events will offer an insider’s view of positions, negotiations, and perspectives from the European Commission, EU Parliament, Council and the ECB.
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