The European financial regulatory environment is one of the most homogenised in the world and yet it still forces corporate treasurers to stay constantly alert for local nuances, revisions and wholesale changes. With the current European Parliament’s term running from 2019 to 2024, now is a good time to cast an eye over what is and what will be in terms of financial market regulations. Tarek Tranberg, Head of Public Affairs & Policy, European Association of Corporate Treasurers (EACT) is our guide.
If 2020 was largely defined for businesses as a year spent firefighting the economic fallout of the pandemic, and figuring out how to work remotely, the European regulatory landscape was about making adjustments to ease the pressure while staying true to objectives and laying the groundwork for the coming years, says Tranberg.
Amid the communications concerning long-term issues such as sustainable finance and the EU’s retail payments strategy, the regulators stepped up to the plate with some quick fixes to existing regulations to ease the burden on banks and companies. Their efforts, for example, relieved some of the pressure on bank capital requirements, freeing up some buffers to enable cash to trickle more fluidly into the wider economy.
The policymakers and regulators have acquitted themselves reasonably well as firefighters. Existing regulations, particularly those relating to banking capital requirements, have so far enabled the financial system to largely withstand the shocks of 2020. Only the possible increase of the European stock of non-performing loans is raising any concern.
But now they are shifting up a gear to take plans forward in 2021/2022 – and several themes are likely to impact treasurers.
From a regulatory perspective, payments can be framed within the wider context of the EU’s desire to develop more independent payment and settlement capacities, says Tranberg. This thinking stems from the on/off Iran sanctions-borne realisation that the US pretty much controls market flow through Visa and Mastercard payment processing.
An attempt to create an alternative way of settling payments came through the EU’s Instrument in Support of Trade Exchanges (Instex) payments platform. This further highlighted the lack of a fully integrated European payments market, even when banking with the same bank across different geographies.
Today, European payments strategy is focused on creating a true single market for payments by bringing down barriers for cross-border payments, promoting instant payments and related innovative solutions, and ensuring interoperability between national schemes.
The strategy has, through the concept of Open Banking, introduced a host of new payments services providers (PSPs), but not all are regulated equally, notes Tranberg. This has persuaded the EU to look again at the second Payment Services Directive (PSD2), with a review scheduled to start at the end of 2021. “They will be looking at the degree to which Open Banking can be extended to other types of accounts, how entities that are not covered under PSD2 can be brought into the rulebook, and to what extent APIs [application programming interfaces] can be standardised to enable greater integration of the payments market,” he notes.
Another part of the strategy will look at reviewing the Settlement Finality Directive to potentially give quasi-bank e-money institutions (such as Revolut and TransferWise) access to central bank payment infrastructures. Currently, deposits from customers of these institutions must be held in a commercial bank account. Settlement access will open up the market to these players and, it is intended, spur competition.
The European Commission (EC) also plans to boost uptake of the SEPA Credit Transfer (SCT) instant payment scheme, says Tranberg. This may take the form of mandate. The aim is to ensure cross-border payment flows within the EU and beyond function as easily domestic payments.
The exploratory work is driven partly by the will to standardise the market. This also manifests in quite an advanced way in Europe’s regulatory response to sustainable finance. The primary legislation that creates the framework for the EU taxonomy is now in place. The Taxonomy gives the market a standard classification system for sustainable economic activities.
In process now is secondary legislation to establish delegated acts, adding detail to primary legislation with technical screening criteria for two of the six taxonomy objectives – climate change mitigation and adaption – now being finalised, notes Tranberg.
As a phased-in requirement, from January 2022 corporates will have to report under the taxonomy’s disclosure rules the extent to which their turnover is derived from taxonomy-compliant activities, and the extent to which their capital and operational expenditure is mapped against taxonomy-compliant economic activities, both under the two technical screening criteria. “While many corporates are aware of this, I’m not sure all are as prepared as they perhaps should be,” Tranberg comments.
This represents the flip side of new reporting requirements, set to come into force in mid-2021 for the investment community under Sustainable Finance Disclosure Regulation. Without sufficient information regarding the sustainability components of an investment manager’s portfolio to be able to submit full disclosure, corporate disclosure requirements were inevitable.
With the Taxonomy as the centrepiece, everything links back to it, explains Tranberg. This connection is driving the EU’s push for a green bond standard; a legislative proposal likely to appear by Q3 2021 and set to create a framework under which issuers can demonstrate Taxonomy compliance and claim eligibility for the EU Green Bond Standard label.
“The green bond market will probably see a significant boost across the EU in the next year or two,” he notes. Indeed, it is part of the €750bn European Recovery and Resilience Facility designed to tackle the consequences of the Covid-19 pandemic, with a commitment made by the EC to raising around one third of the overall amount in EU green bonds.
This commitment will bolster the initiative, but the EACT has pushed the EU for green bond programme flexibility. This would allow issuance where the activity being funded is not fully Taxonomy-compliant, and enable green bond labelling of a general corporate purpose bond. As Tranberg explains, most corporates don’t raise funds for specific projects but rather channel the funds raised as required. “The notion of having to ring-fence funds for specific purpose is not always the most practical and is probably one of the reasons for low uptake.” Flexibility will encourage greater activity.
Financial crime remains an issue globally, and in early 2021 (late April/early May) the EC will be proposing reforms to the EU’s anti-money laundering (AML) framework. The twin focus will be on the establishment of a European supervisory authority for financial crime, and on plans to harmonise current requirements across all 27 member states.
The supervisory authority is viewed in part as a response to events that unfolded in 2019, when €200bn of ‘suspicious transactions’ in Estonian branches of Danske Bank were uncovered, and then 2020’s Wirecard fraud in Germany in which €1.9bn in cash ‘went missing’. Both incidents are what Tranberg perceived as the “abject failure of the national regulator to spot money laundering within a sizeable payment processing entity”.
The new authority is to create harmonised oversight of significant financial institutions, along the lines of the European Central Bank’s single supervisory mechanism for banks. The largest entities will fall under direct EU-level supervision, smaller ones can be dealt with nationally, but national supervisors may still seek EU-level help where suspicious cross-border activity arises. While there is little intention of corporates being brought under direct supervision for the time being, the intention to tackle financial crime is evident.
A second pillar of response aims to turn what are currently EU directives on AML, allowing a degree of latitude for transposition into local law, into regulation, where no such freedom is given. “This is potentially a major upside for corporates, giving one set of rules for all member states for AML, KYC [know your customer], and customer due diligence requirements,” comments Tranberg.
An additional element that should be considered as part of these reforms, which could facilitate customer onboarding, bank account management and KYC processes, is a wider use of unique legal entity identifiers. Creating legal obligations for use of the global Legal Entity Identifier (LEI) system – for example in EU AML rules – could deliver significant benefits for corporates in tackling KYC-based pain alone.
Meanwhile, banking and financial services sectors will see the delayed review of Basel III’s capital requirements directive swing into action in 2021. The EC had its proposal lined up for May 2020, but with the Basel Committee postponing implementation of outstanding phases by one year, Tranberg says the EC was spared a rush to push out the legislation immediately. Q3 2021 is likely to be the new date in the diary, he says, adding that “it remains to be seen what lessons will be drawn from the crisis in how the Basel standards will be implemented”.
One current exemption in bank capital rules in Europe – the credit valuation adjustment (CVA) exemption – reduces the capital amount required to be held against corporate hedges. When rules are revised, Tranberg urges treasurers to check that all such exemptions are retained. “If the CVA exemption were to be removed, the cost of hedging would overnight become significantly more expensive for corporates,” he states.
Again, the EACT has the EC’s ear on such matters, making it abundantly clear that removing the CVA exemption would have a negative impact on a corporate sector trying to manage volatility created by the pandemic.
From a purely corporate perspective, concerns have also been expressed about the capital treatment of some derivatives exposures by banks. Of most concern is the weighting of capital requirements that banks must hold against, for example, exposures to unrated corporates, certain instruments (such as trade finance instruments), and specialised corporate lending facilities. If the rules go the wrong way, they could impact either bank willingness to provide these services to corporates or the cost of doing so.
Basel revisions will also introduce an ‘output floor’ on capital calculations. With banks required to use a standardised model for calculating capital, but given freedom to use internal models, an output floor will mean that whatever the outcome of an internal model, it cannot be lower than 72.5% of what the standardised approach gives. “For many banks, capital requirements may rise, which will lead some to conclude that business will be more expensive and that they will not be able to lend as much,” notes Tranberg.
Capital markets regulations are set on a pathway to build a fully integrated capital market for member states, with a more wholesale overhaul of MiFID II slated for 2021/2022. This could include changes to market structure, the transparency framework, and possible introductions of fresh trading obligations for new asset classes.
Notable for corporates would be any new requirements for foreign exchange markets. Bond trading is also under a watching brief. With a significant trading volume of European shares shifting from London to Amsterdam in recent months, some see the logic (perhaps more with a political mind than a financial one) of forcing euro-denominated bonds to be traded on European exchanges, says Tranberg. “It may not fly but treasurers should at least be aware.”
With consolidation of post-trade market data pricing across the EU markets for some instruments, a “low hanging fruit” here could be the creation of a consolidated tape of data for the corporate bond market, he says. However, there are technical challenges to overcome in the provision of instantaneous data across such a wide geography, notably the latency inherent in data consolidation and distribution. Apart from that, there are also wider issues to tackle, such as how the provision of such a tape would be put out for tender.
Technology is obviously now a key part of the corporate financial landscape, and the EC’s digital finance package, adopted in September 2020, lays the groundwork for many new ideas. It incorporates a digital finance strategy with legislative proposals on crypto assets and digital resilience. With several established regulatory sandboxes and pilot schemes, the aim is to encourage innovation while preserving financial stability and consumer protection, says Tranberg.
One of the goals is to build a policy framework for artificial intelligence (AI), which includes proposals for a civil law on liability for AI in case of damages. Of more immediate impact will be the proposed common legislative approach to crypto assets and the development of Central Bank Digital Currencies, with the ECB already exploring the notion of a digital euro.
The EACT was active during the ECB’s consultation phase, noting that it would be an interesting prospect for treasury, with digital currencies likely to ease corporate aversion to holding cash. However, it also emphasised the lack of coverage by current AML rules for the structuring and use of crypto currencies.
With the ECB’s explorations of a digital euro likely to yield a go/no-go decision by Q2 2021, Tranberg believes a green light will herald a period of testing and adaptation of the accompanying regulatory framework.
Elsewhere, the financial authorities are closely monitoring the operational resilience of the sector as it may be impacted by outsourcing of critical infrastructure. The Digital Operational Resilience Act is under negotiation within European Parliament and Council. It considers how financial institutions are able to outsource, for example, to a cloud provider, and what requirements, in terms of negating any institutional exposure, must be fulfilled when this course of action is taken.
One change that is reaching a regulatory conclusion is the transition away from the London Inter-bank Offered Rate (Libor) to new risk-free rates (RFRs), with amendments and exemptions to the EU Benchmarks Regulation, including derivatives fallback protocol, on the table. However, among RFRs, Tranberg notes that there are no full alternatives to Libor yet in terms of how they are structured and whether they are future-looking or based on historic transactions.
With the current crop of RFRs being based on the overnight swap market, although based on actual transactions, they do not provide a look into the future. “Even if they will do – and the UK is exploring a compounded SONIA [Sterling Overnight Index Average] that is forward looking, and the EU is contemplating a forward-looking compounded rate – the issue is that the compounding formula is likely to be based on an historic median.”
While there are differing views as to the helpfulness of using historic data to project the future (and to what extent it is better or worse than Libor), the reality is that Libor is going to disappear. However, ICE Benchmark Services, the Libor administrator, has consulted on the cessation of the various rates and has said it will keep some tenors of USD Libor running until June 2023.
Although other Libors will cease on 31 December 2021, the predominant exposure of corporates is medium term and USD Libor. The ICE extension is thus “helpful”, allowing a significant number of contracts to run off before transition, notes Tranberg.
For those that are not covered, the Benchmarks Regulation Review of 2020 saw the EC put its statutory fallback mechanism in place. This allows for the smooth transition of contracts still open at Libor cessation. The statutory fallback rate applied may not prove to be the most attractive, but it is intended only as a backstop and will not override any fallback privately agreed between corporates and their bank or other counterparties.
The Benchmarks Regulation Review of 2020 also sought to tackle overly restrictive third-country rules for a subset of non-EU indices. When these rules were drafted, the assumption was that many jurisdictions across the world would implement similar legal frameworks, says Tranberg.
With most actually relying for their benchmarks on International Organisation of Securities Commissions (IOSCO) principles rather than legislating domestically for them, the lack of equivalent or recognised frameworks in these jurisdictions makes it difficult to grant non-EU benchmark administrators access to the European market.
Aware of the problems this would cause, a transitional concession was made in 2020’s review enabling European users to continue using non-EU benchmarks for a further two years. This will allow time for the third-country rules to be tamed. It also carved out spot foreign currency (FX) benchmarks for use even after the end of the transition period. This is particularly important because at that point, FX benchmarks for non-deliverable currencies would cease to be available for European users.
Last but not least, corporate, financial and digital tax regulations are subject to international and European workstreams. International affairs are conducted at the Organisation for Economic Co-operation and Development (OECD) level and include initiatives such as the base erosion and profit shifting (BEPS) project that seeks to disrupt multinationals exploiting gaps and mismatches between different countries’ tax systems. So far, the BEPS framework has seen more than 135 countries collaborating to end tax avoidance.
The OECD is also engaged in discussions on a digital levy. Progress held back under the Trump presidency may yet see forward motion under the Biden administration. In the light of the difficulties at OECD level, the EU has stated that if progress is not made, it will consider creating its own digital tax, applicable to firms profiting from European data and citizens. While this is aimed at Big Tech firms, how far it reaches into the e-commerce and even financial services sectors remains to be seen. Treasurers should keep a watching brief.
There is movement too at EU level in the quest to mandate corporate public per country reporting of tax payments and profits. If implemented, it would require any corporate – European or otherwise – that has significant operations in the single market to disclose, on a country-by-country basis, its profit levels and tax payments.
Additionally, for both listed and non-listed businesses with a consolidated global turnover of more than €750m, disclosures could be required in the EU of the level of tax paid and profits made, on an aggregate basis, outside of the EU. The same reporting would be required where business is conducted in any jurisdiction that is classified as a non-co-operative tax jurisdiction.
Financial regulation is necessarily a complex and challenging affair. What’s covered here just scratches the surface of existing and planned activity at a European level, often with legislative and regulatory tentacles reaching around the world.
For treasurers, awareness and understanding of it all, and formulating the most appropriate responses, may seem like a full-time job in itself. National treasury associations and bodies such as the EACT, play a vital role not only in advising the community but also in advocating during consultation periods. For more information on any of the topics covered contact: email@example.com
Interview by Tom Alford, Deputy Editor, TMI, with Tarek Tranberg, Head of Public Affairs & Policy, EACT