In 2023, the European Union (EU) embarked on a major reform effort, with the European Commission, EU Council, and European Parliament establishing their joint legislative priorities. With a particular focus on financial services, this initiative presented a significant shift in regulatory oversight of banking and insurance sectors. The transformation was underpinned by several key priorities.
Evolving the Banking Package
The Banking Package, including regulation on credit risk, credit valuation adjustment risk, operational risk, market risk, and the output floor, was given due attention for development. These amendments were designed to strengthen the existing framework, by introducing improved supervisory powers, sanctions, third-country branch regulations, and addressing environmental, social, and governance risks. The updated Basel 3 protocol forms a crucial part of these amendments and is approaching its final stages of ratification.
Despite some ongoing disagreements between the European Parliament and the Council, such as on transitional periods for unrated corporate exposures and the regulatory treatment of cryptoasset exposures, the overarching approach aligns with the European Commission's strategy of incorporating transitional periods and departures from the Basel framework to temper the capital impact.
Revising the Bank Crisis Management and Deposit Insurance Framework
The crisis management and deposit insurance (CMDI) framework, an integral component of the EU's banking regulatory structure, was also subject to revision. The aim was to bolster the existing CMDI rules and fortify the stability of banks, regulate supervisory cooperation, and manage banks in distress.
The proposed amendments were expected to reform the Single Resolution Mechanism Regulation (SRMR), the Bank Recovery and Resolution Directive (BRRD), and the Deposit Guarantee Scheme Directive (DGSD). Despite the EU banking framework's goal of unifying three pillars of EU banking, it was clear that further improvements were needed. This was particularly true for the deposit guarantee scheme and the approach to dealing with small and medium-sized banks, whose dependence on deposits made resolution more costly.
Establishing a Framework for the Recovery and Resolution of Insurance and Reinsurance Undertakings
An essential part of this reform was the Insurance Recovery and Resolution Directive (IRRD), proposed by the European Commission. It aims to establish a cohesive framework for the recovery and resolution of EU insurance companies and their affiliates, intending to ensure swift interventions in case of potential failure, thereby reducing economic impacts and safeguarding policyholders.
This new legislation demanded the establishment of resolution authorities and placed considerable compliance obligations on insurance institutions. It provided comprehensive tools to maintain the continuity of essential services and manage the failure of an insurance institution in the public interest, all while ensuring safeguards for shareholders, creditors, and policyholders.
The IRRD was also unique in its approach to non-EU insurers, allowing resolution authorities to recognise and apply comparable resolution actions taken by non-EU authorities in relation to EU subsidiaries, EU branches of non-EU insurance institutions and parent companies.
As the final version of the IRRD is anticipated for late 2023 or 2024, insurance institutions must begin preparations for adapting to this new regulatory landscape.
The 2023 legislative priorities marked an ambitious step towards refining the EU's regulatory frameworks in banking and insurance. While challenges persist, these changes signify a concerted effort to ensure financial stability, foster stronger supervisory measures, and safeguard the interests of policyholders and the public at large. As we move closer to the anticipated implementation date of January 1, 2025, all eyes will be on the banking and insurance sectors' adaptation to these new regulations.
The Dynamic Regulatory Landscape of the EU Financial Market
The European Economic and Social Committee (EESC) is discontent with the slow progression towards EU-based clearing operators post-Brexit. There is a call for a comprehensive strategy and concrete rules to expedite this shift, particularly given the sheer scale of a EUR 81 trillion derivatives market. The EESC also advocates for increased transparency on the EU clearing system to ensure understanding of financial stability risks.
The EESC echoes concerns about the EU's excessive dependence on UK central counterparties (CCPs) and applauds the lack of exceptions for entities from high-risk jurisdictions or non-cooperative tax jurisdictions. The Committee welcomes changes to Article 23, such as the proposed creation of joint oversight teams and a Joint Monitoring Mechanism. However, the Committee suggests that the Commission's five-year review period is excessive and calls for eased access and a reduced administrative burden for the European clearing system.
In a bid to enhance the stability, predictability, and proportionality of all clearing operators, the proposal aims to regulate third-country exposures. The Committee urges prompt action considering recent geopolitical disturbances and the resulting economic repercussions. EESC further highlights the importance of developing an EU clearing system with the entire supply chain in mind, and maintaining market liquidity while limiting exposure to UK CCPs.
Amendments have also been proposed to the Central Securities Depositories Regulation to increase the efficiency of EU's settlement markets while ensuring financial stability. This proposal, integral to the 2020 Capital Markets Union Action Plan, aims to make securities settlement in the EU more secure and efficient, enhance the allure of EU's capital markets, and support the financing of the economy. The proposed changes include simplifying passporting for CSDs, improving cooperation between supervisory authorities, and more.
In a parallel move, the European Commission has adopted a Retail Investment Package aimed at placing consumers' interests at the heart of retail investment. The initiative is part of the 2020 Capital Markets Union Action Plan and seeks to encourage greater participation in EU capital markets. The measures included in the package aim to standardize information about investment products, enhance transparency, and comparability of costs, address potential conflicts of interest, safeguard investors from misleading marketing, promote financial literacy among citizens, and more.
However, the journey of regulation reform is fraught with challenges. Investor protection rules are currently dispersed across sector-specific legislative instruments, leading to potential inconsistencies and confusion for retail investors. Furthermore, digitalization has revolutionized distribution models and marketing methods for financial instruments. The Commission is leveraging evidence collected over the past three years, including in-depth studies and public consultation exercises, to create this comprehensive investment package.
The comprehensive regulatory changes in the EU financial market reflect the critical need for efficiency, transparency, and investor protection in a rapidly evolving global economy. As geopolitical uncertainties continue to create ripples in financial markets, the EU's concerted efforts to reinforce its regulatory frameworks are a step in the right direction.
Financial Transparency and Efficiency: European Single Access Point, Open Finance Framework and Revised Regulations
In the evolving landscape of the global financial market, the European Union (EU) is striving to provide an effective, transparent, and innovative financial environment. A multitude of initiatives and regulatory changes are underway to achieve this objective. Key among these are the development of the European Single Access Point (ESAP), the Open Finance Framework, and amendments to the MiFID II and MiFIR regulations.
The European Single Access Point (ESAP) initiative, proposed by the European Commission on November 25, 2021, will serve as a unified platform providing comprehensive access to public financial and sustainability-related information about EU companies. The ESAP will enhance the visibility of businesses, especially small ones, and enable them to secure more financing opportunities. This initiative is integral to the EU's Digital Strategy, aligning it with the goals of the European Green Deal and the Commission's renewed action plan on the Capital Markets Union 2020.
Simultaneously, the European Commission is forging ahead with the Open Finance Framework. This initiative will permit third-party service providers to access customer data across a wide range of financial services, with customer approval. A critical part of the Digital Finance Strategy, Open Finance will enhance innovation in the sector and improve customer choice. This framework aims to alleviate legal, contractual, and technical challenges surrounding data access and reuse, ensuring a harmonized regulatory landscape across the EU.
Moreover, the European Commission has proposed significant changes to MiFID II and MiFIR regulations to enhance market transparency and streamline data flows. Key changes include the amendment of several articles to update the MiFID II provisions, expanding the definitions of 'multilateral system' and 'consolidated tape provider', adjusting rules for the deferred publication of transactions and trading obligations, and establishing new mechanisms for data quality management and sanctioning non-compliance.
The ESAP, Open Finance Framework, and amendments to MiFID II and MiFIR regulations collectively demonstrate the EU's commitment to boosting financial transparency and efficiency. The efforts aim to empower investors and businesses, promote sustainability, foster innovation, and ensure regulatory compliance, thus strengthening the EU's capital markets. This collaborative and innovative approach positions the EU at the forefront of global financial market evolution.
Revisions to AIFMD and Development of AML Framework in the EU
On November 25, 2021, the European Commission presented its suggested modifications (the Initial Proposal) to Directive 2011/61/EU on alternative investment fund managers (the AIFMD) concerning delegation arrangements, liquidity risk management, supervisory reporting, depositary and custody services, and loan origination by alternative investment funds. Following this, a preliminary report by the European Parliament (the Parliament) was released on May 16, 2022 (the Report). Subsequently, the Council of the European Union (the Council) proposed its amendments on June 21, 2022 (the Council Proposal). After extensive negotiations, a political agreement was reached by the Parliament’s Committee on Economic and Monetary Affairs (ECON Committee) on January 24, 2023 (the EP Proposal).
The EP Proposal confirms several beneficial amendments suggested by the Initial Proposal or the Council Proposal, while some favorable changes for the fund industry were omitted from the Parliament’s final stance. This write-up focuses on the key elements of the EP Proposal, with the understanding that further modifications may arise during the trilogue discussions. Some of the primary features of the proposal include defining professional investors, detailing the application process for AIFM’s authorization, expanded reporting obligations, and the use of ESMA registers, and implementing specific regulations for loan origination by AIFs.
Moreover, members of the European Parliament (MEPs) have adopted their stance on a set of draft legislation designed to address issues relating to money laundering, the funding of terrorism, and evading sanctions within the EU. This decision came about through the efforts of the Economic and Monetary Affairs and Civil Liberties, Justice and Home Affairs committees. The legislative package includes the EU “single rulebook,” a regulation that contains provisions for carrying out customer due diligence, transparency of beneficial owners, and the use of anonymous instruments such as crypto-assets.
Another crucial component is the 6th Anti-Money Laundering directive, which includes national provisions on supervision and Financial Intelligence Units. This directive also emphasizes the need for competent authorities to access necessary and reliable information such as beneficial ownership registers and assets kept in free zones. Also, a regulation has been introduced to create the European Anti-Money Laundering Authority (AMLA), a body with supervisory and investigative powers, ensuring compliance with anti-money laundering (AML) and countering the financing of terrorism (CFT) requirements.
It's important to note that both these changes in AIFMD and the proposed AML framework are going through the legislative process and may still be subject to further amendments. Stakeholders should closely monitor these developments, as the final text will significantly impact the way alternative investment funds are managed and how anti-money laundering measures are enforced in the EU.
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