After many months of lockdown and having had only 5-10% of staff in the office, investment banks are now looking to phase a fuller return to offices. This has been a hugely challenging period and, being very careful to avoid complacency, banks can take pride in how they have performed so far. Having shifted to remote working in what felt like only a few days, banks have shown their resiliency by continuing to service markets and clients, during a period of real volatility, with few operational issues. Underpinned by a broader strategy of increased digitalisation and adoption of new technologies, how banks now continue to harness technology will be key as they navigate their next challenge; striking the right balance for a ‘new normal’ as staff return to offices. One of the main factors that will influence return to office is how well staff have worked remotely. The majority of staff have been working away from the main sites with many working from home; only a small percentage of key workers, predominantly trading staff, have continued to work from the office. Compliance and control obligations have been maintained through the use of remote infrastructure to access central trading systems, the use of always-on virtual trading room software, recorded chat facilities, and mobile phone voice recording. This has helped counter the loss of line-of-sight and day-to-day oversight that compliance officers would typically have when working on the same floor as traders. The resulting smooth transition to remote working means that organisations may have less pressure to return to the office. What is clear at this stage is that any return will be cautious, phased and geared towards staff safety. It is likely we will see more of the front office moving back first, with middle and back-office teams continuing to work remotely for longer. This phased return means banks will need to judge whether their remote trading environments are “controlled” enough and if additional technology solutions need to be implemented. This may include the greater adoption of cloud-based software to support offsite workers and the potential use of new monitoring solutions to better enable the outsourcing of certain operations. Importantly, in determining return to office procedure, banks will need to ask themselves how long they believe the pandemic’s operational impact will last. If the impact is only expected to be a few months, the return to work might mean that many pre-pandemic processes can be retained. However, if the implications are longer-term (e.g. 6-24 months), internal procedures are likely to need to be further revised. For instance, this could include re-developing processes to train graduates remotely or rolling out new “hybrid” surveillance systems. Moreover, if the company is in the process of a business-wide technology transformation, this might need to be catered for with staff rotational patterns that enable teams to be gradually onboarded. Another change that could arise from remote working is how organisations address work-life balance. While it can be expected that most traders will eventually return to the office, the lockdown has proven that they have to a large extent successfully performed their jobs remotely, where previously it was perhaps judged too complicated – and risky – to set up the correct controls from home. This could afford organisations greater flexibility in allowing traders to work from home more frequently, knowing that it will improve their quality-of-life without impacting the bottom-lines. Going forward, one potential benefit of having this more flexible work culture might also be to help organisations in recruiting and retaining diverse talent. As the world navigates this unprecedented period, a “new normal” for businesses is likely to emerge that may look very different from the past. Banks have had to react quickly to the threat of coronavirus, and the new working environment is evolving rapidly along with the technology to support it. However, despite this change, so far banks have again proven themselves resilient. Even though the duration of the lockdown and the future of the office workspace remains unclear, there is no doubt that banks are prepared for the challenge.

On the 3rd of April 2020 the European Commission published its ‘Digital Finance Strategy’, which set out an ambitious vision for the transformation of financial services through increased digitisation. Technologies such as Cloud, Artificial Intelligence, Distributed Ledger Technology (DLT), and a growing focus on the value of data-sharing, will play a central role in transforming financial services. The global response to the recent COVID19 pandemic has illustrated the importance of technology to increase the resilience of financial infrastructures. Technology has played a key role in enabling remote working and allowing financial markets to continue to function during the crisis. The role of crypto-assets, types of digital financial assets, is consequently expected to accelerate in importance as financial services become increasingly digital. It is therefore essential to recognise the various use-cases, features, benefits and risks of different types of crypto-assets in order to clarify their regulatory treatment. By bringing crypto-assets within the regulatory perimeter, regulators can further support innovation in this area. What are crypto-assets and how are they different from traditional financial assets? Crypto-assets are financial assets that are represented digitally using Distributed Ledger Technology (DLT) and cryptography. It is the use of these technologies that differentiates them from traditional financial assets: Distributed Ledger Technology (DLT), such as blockchain, is used to create a decentralised network for recording and storing information in multiple locations, without the need for a central administrator (such as a financial intermediary). Cryptography is a method of encryption that is used to create ‘digital keys’ to manage ownership or control of a crypto-asset, providing security for the recorded information to prevent tampering or theft. Crypto-assets have a wide range of current and potential use-cases in financial services, such as securities trading (as shares or bonds) or improving post trade processes (such as settlement and recording ownership). Crypto-assets also have a wide range of features. For example, some crypto-assets, often referred to as ‘stablecoins’, have built-in price stabilisation mechanisms that link them to other financial assets or algorithms (a programmed sequence of executable instructions). Other crypto-assets are programmed to automate key functions like dividend pay-outs, or contain smart contracts that automatically execute all or part of a legal agreement when programmed to. It is important to understand the various use-cases and features of different crypto-assets because they are associated with different levels of risk. For instance, some crypto-assets (e.g. tokenised securities) are issued by regulated financial institutions and are essentially digital, cryptographically secured versions, of traditional financial assets and subject to existing regulations. However, other crypto-assets (e.g. cryptocurrencies) currently fall outside of existing regulations and may contain features (such as anonymity and unrestricted access) that may make it difficult, or even impossible, to conduct the controls necessary to protect investors, consumers and financial markets. There are multiple benefits that crypto-assets can provide compared to traditional financial assets, such as: Allowing for increased efficiency and cost-savings by reducing the need for financial intermediaries; Increasing investor access to asset classes through fractional ownership (where an asset is split into smaller investments); Providing a more secure and accurate store of information (by creating tamper-resistant records); Distributing information between multiple participants in real or near-real time (to mitigate risks such as single points of failure); and Increasing the speed and efficiency at which capital can be provided (for instance by allowing for faster post trade settlement). The potential benefits of crypto-assets can be understood in the context of the recent COVID19 pandemic, where European capital markets have played a vital role in supporting the economic response, and recovery, required. The benefits of crypto-assets (such as increased efficiencies and improved resilience of financial services) will become more pronounced as their adoption continues to increase and where other disruptive events, such as the current crisis, occur. Even so, increased adoption and further innovation for crypto-assets remains hampered by a lack of clarity on their exact regulatory treatment. This lack of clarity stems from two main factors: Crypto-assets have a variety of features and use cases: There are many different types of crypto-assets that are used to conduct a wide range of activities, with varying features and risks; and There is no commonly used global taxonomy: There is no globally accepted taxonomy for classifying crypto-assets, to take account of these variations and to help identify the appropriate regulatory treatment. It is therefore essential to establish a global taxonomy, that distinguishes these different activities and features, to encourage innovation, realise the potential benefits and appropriately manage any associated risks. Why are crypto-assets so difficult to define and classify? Crypto-assets, whilst evolving at pace, remain at an early stage in their development and use within financial markets. Therefore, identifying the appropriate regulatory treatment has proven difficult as current regulations were not developed with crypto-assets in mind. For example, existing regulations are generally built on the basis of ‘bilateral relationships’ (a linear relationship between the seller, intermediaries, and buyer respectively), whereas crypto-assets are able to facilitate multiple interactions between decentralised parties. This has resulted in a fragmented approach to crypto-assets regulation across EU Member States (and globally). This creates uncertainty for market participants as to which rules will apply to the issuers of crypto-assets and related service providers (such as those providing exchange or custody services). Clarity on what rules will apply is necessary for encouraging crypto-asset adoption and innovation. The need for a global taxonomy to classify crypto-assets In December 2019 the European Commission issued a public consultation for the development of a comprehensive regulatory framework for crypto-asset markets in Europe. This framework will be an important step towards harmonising crypto-asset regulation in Europe and creating a common baseline of understanding for market participants. However, a global crypto-asset taxonomy is still required due to the global nature of financial markets; and particularly for those market participants engaging in cross-border activity. This global taxonomy must be high level in order to remain flexible as crypto-assets continue to develop, but detailed enough to provide the regulatory clarity required to encourage innovation. Industry collaboration across the EU, and globally, will be essential in achieving this taxonomy and in realising the benefits of crypto-assets, whilst mitigating any risks. AFME initiatives In support of a European, and global, crypto-assets taxonomy, AFME (as part of the Global Financial Markets Association, GFMA), has developed an initial approach for the classification of crypto-assets. We believe this approach provides an important basis for a future global taxonomy and that it can support the collaboration required between financial market participants and regulators to achieve this aim. The approach we developed is based on the principle that the regulatory treatment of crypto-assets should be underpinned by a clear understanding of the existing features of crypto-assets and their associated risks. We believe this approach will support the development of an appropriate framework for crypto-assets regulation in Europe, and globally, as crypto-assets continue to evolve and new offerings are created. You can find our approach here, in Annex A (p 10-12) of our response to the BCBS Discussion Paper on Designing a Prudential Treatment for Crypto-assets. You can find our response to the European Commission public consultation on An EU Framework for Markets in Crypto-assets here.

The economic shock generated by the Covid-19 pandemic has amplified the need for deep and well-integrated capital markets in the EU in virtually every area. As Europe faces its deepest ever economic recession, itis clear that arobust post-pandemic recovery and sustainable long-term growth cannot be funded solely throughgovernment support programmes and the provision of bank loans.Strong capital markets are needed to channel the EU’s significant savings pools and private investment resources to where they are most needed. The implications of Brexit, meanwhile, remain a key driving force behindthe Capital Markets Union (CMU) project. The way EU businesses and market participants interact with the City of London – Europe’s deepest financial centre and wholesale markets hub – is set to be reshaped at the end of the Brexit transition period, even if optimistic scenarios for equivalence determinations and the future relationship materialise. The question facing CMU is therefore not if it is needed, butwhether policymakers will nowseizethe opportunity to generate the momentum to undertake the reforms needed to fulfil the objectives of this critical single market project. Established in November 2019, the European Commission’s CMU High-Level Forum (HLF) brought together a diverse group of experts from different sectors tasked with the preparation of recommendations that were ambitious and game-changing, but also concrete and actionable.Its long-awaited report, published this week, identifiesmany of the measuresthat need to be taken forward. Placing equity markets and retail investors at the heart of the CMU Are-equitisationof Europe’s companies and financial landscapeis one of the immediatepriorities in the face of the Covid-19 crisis. Public and private equity risk capital remain the most appropriate mechanisms to finance manybusinesseswith high-growth potential, aiming to rapidly expand or to invest in frontier technologies. Supporting them is vital to the recovery. Theyrepresent riskier investments but are alsolikely to bethedrivers of post-crisis growthand job creation.Well-functioningequity markets should also allowestablishedcorporates tostrengthentheir balance sheetsin the face of a very sharp downturn in business activity. TheHLF Report puts forwardanumber ofrecommendationsto bolsterequity markets. These include adjustments to the prudential frameworks for banks and insurers to increase institutional investor capacity, the establishment of a EuropeanSingle Access Pointto improve access to company financial information across the EU,as well astargeted modifications of the prospectus, market abuse and MIFID/R regulatory frameworksto make public listing more attractive in particular to SMEs. Some topicswill require further assessment anddiscussion. For example, while promoting equity research coverage on SMEs is avery legitimateaim, creating a bespoke treatment for SMEswith exemptions from theMiFIDII unbundling rulescouldlead tofurther regulatory complexityand other drawbacks. Another central priority is the expansion of retail investor participation in EU capital markets. A large part of the wealth of European householdscontinues to be placed incash deposits with currently negative real returns.This must change if we are to unlock thetrue potential of the CMU.Increasing the supply ofinvestable capital is one of the conditions to supporting businessesand mobilisinginvestmentsto help mitigate the impact ofclimate change. A further important recommendation in the HLF Report istosupportthe introduction of auto-enrolment systems to stimulate adequate pension coverage across all Member States. Experiencein some jurisdictionssuggests that auto-enrolment schemescan lead to very significant growth in pensions savings over a relatively short period of time, thereby increasingthe pool of capital available for investment.The implementation of such schemes has the potential to be atrue game-changerin several countries. Revisiting pastCMUinitiatives – can theybesuccessfully delivered this time? The framework for simple,transparentand standardised (STS) securitisationrightlyconstituted one of the building blocks of the initial CMU Action Plan. Yet the potential of the STS framework and the ambition to promote a safe and expanded European securitisation market are so far not being achieved.Over a decade on from the financial crisis, issuance in Europe is still at a fraction of the level it once was(figure below).This is in part due to an excessively complex regulatory framework and an overly conservative treatment of securitisation that continue to discourage a meaningful recovery of the European market. TheHLF Reportprovidesa set of clearly defined recommendations in this area. Itrightly concludes that a review of the securitisation rules should seek to simplify the process for significant risk transfer, adjust the prudential treatment of securitisation for banks and insurers, support the development of synthetic securitisation, reconsider the eligibility of securitisation under liquidity regulation and simplify disclosures. These are the right measures. Policymakers must now prioritise the adjustments needed to ensure that Europe can benefit from well-functioning securitisation markets and the possibilities offered by the “best in class” STS label. There islong history of European initiativeswhich haveaimed totackleinstances of fragmentation intaxation regimes, insolvency procedures and legaldefinitions.Progress in these areas has been slow and challenging due todivergentnationallawsand legal systems. Yetsuchlegalframeworks are fundamental inunderpinning the functioning ofcapital markets and building a true CMU. One can only hope that Member States will find the willingness to implement the HLF’s recommendations to overcomedeep-seatedinefficiencies and legalimpediments to capital market integration. Theintroduction ofa standardised system for relief at source of withholding taxshouldcertainlybeone of thepriorityactionsto addressacostlysource of friction in intra-EU business. The securities markets structure – inefficiencies need to be tackled EU markets have shown resilience in the recent period of high stress and volatility, with financial firms and infrastructures continuing to fulfil their core functions without major systemic disruptions. However, further work is needed to improve the effectiveness of the securities market structure, which is central to the future success of the CMU. Capital markets needcost-effective channels for the issuance,distributionand trading of securities for the benefit of investors and non-financial companies. They need well-calibrated transparency regimes that support liquidity and market confidence. For thisreasonthe upcoming reviews of the MiFID II/MiFIR framework should be pursued in alignment with the CMU objectives to strengthen the capacity of EU capital markets and enhance their efficiency and connectivity. The priorities must include addressing – and removing – deepinefficiencies in Europe’s equity market structure. Chief among thesearethe share trading obligationand the double volume caps system,whoseeffects have not been positive for Europe’s markets.Another focus area should be tacklingpersistent problems regarding the high cost of market data, which is a fundamental concernto many market participants. As regards post-trade market infrastructures, the HLF hasregrettablymissed an opportunityto recommend a review of the CSDR settlement discipline regime in order to remove the mandatory obligation on investors to execute buy-ins, despite putting forwardtargeted recommendationson other aspects ofthe CSDR. Thisobligation,which is due to go livein February 2021,willrestrict the ability of investors to manage their trading and settlement processes, risking damage to liquidity, greater costs and higher barriers to investing.It is unfortunate that theHLFwas not able to reach a consensus on this point. Conclusion The importance of the CMU project hasneverbeenmore obvious.The upcoming reviews of key legislations – MiFID/R, CSDR, Solvency 2, the Securitisation Regulation and the bank prudentialframework, among others – must be pursued with ambition andaclear focus on the CMU’s aims toexpand, integrate and make more efficient the EU’s markets. The impact of the Covid-19 crisisshouldserve as a catalyst to overcomenational differences and legislative discrepancies thathaveweakened pastinitiatives.As the EU navigates one of its greatest evereconomic and socialchallenges, the hope is thatall partieswill seethevastpotential of a fully-fledgedCMU in aiding economic recovery and supporting sustainable growth.

Following the hard-hitting impact of the Coronavirus lockdown, Europe’s economy is facing an unprecedented challenge. The European Commission has forecast the euro area economy will shrink by 7.75% this year. The depth of the recession and the strength of recovery will be uneven across the EU. During this difficult period, the effectiveness of the recovery will be shaped by how well the banking sector, capital markets and authorities can work together to support European businesses. When EU countries emerge from the Covid-19 crisis, it is expected that they will have to shoulder higher levels of debt as a result of the support provided to entire sectors closing down under the lockdown restrictions. Although European governments and banks have responded rapidly with the liquidity to fund companies, a robust and sustainable post-pandemic recovery cannot solely rely on bank funding. It is important to mobilise the entire range of options and solutions in the single market, including the investment capacity and interest available across Europe and beyond. Therefore, now more than ever, Europe needs to promote market-based finance. In this respect, equity finance should be especially important in supporting the EU’s recovery. Funding via Initial Public Offerings, private equity, venture capital and crowd funding are going to be crucial vehicles to support businesses. Corporates and SMEs, particularly those looking to invest in new technology, to hire staff for rapid expansion or to re-finance existing loans post-pandemic, will require affordable, appropriate funding to facilitate their future growth. Equity finance is well-suited to this as it can be raised from a diversity of investors even amid volatile market conditions. Businesses with high growth potential will be the backbone of the future European economy and supporting them will be key to a resilient post-pandemic recovery. There is significant room for growing Europe’s equity markets. In 2019, European exchanges saw 106 companies go public, while over the same period, the US saw 196 IPOs. Improving and converging key regulatory requirements governing the IPO process could help to reduce the cost and execution risk for companies going public and widen the pool of interested investors across Europe. Another way to support European businesses during the recession is to foster a well-functioning securitisation market. Bank loans will continue to be the primary funding tool for many businesses and households. Securitisation can provide funding for companies in a tight credit environment by enabling banks to free up their balance sheets and capital needed to lend to SMEs, corporates and households. Yet, while a robust securitisation market would aid Europe in its post-crisis recovery, over the past year, growth in the market has been stagnant. This can be attributed to an excessively complex and restrictive regulatory framework that has deterred many investors. Reviewing this framework should enable more investors to enter the market and allow for greater financing of EU businesses. Of course, while immediate relief measures are needed to rebuild the economy, we must also ensure the recovery is sustainable. There are growing calls for a “green” recovery – one that accelerates progress in building a sustainable and carbon neutral economy. In this respect, the EU's green recovery mustbe based on the EU taxonomy - which aims to encourage investors and consumers to identify economic activities that can unambiguously be considered environmentally “green”. As Europe navigates one of its greatest ever challenges, it cannot afford to neglect how important capital markets will be in aiding its recovery. How banks, authorities and capital markets work together to fund EU businesses will not only determine how quickly it recovers, but how sustainable Europe’s rebuilding will be. Later this year, when the European Commission reviews its priorities for the next phase of the Capital Markets Union – a long-term project intended to unlock funding across Europe - the strengthening of certain criticalareas of capital markets must be top of its agenda. With a global recession on the horizon, EU businesses are going to need to consider every available source of debt and equity capital to bounce back stronger. This opinion was originally published in Les Echoson 4 June 2020

The covid-19 pandemic has led to tragic personal loss and wreaked economic havoc on a huge scale across the globe. On the economic front in Europe, the ECB’s estimates for Eurozone GDP this year range as low as -12%. Governments have rushed to support their people and economies through a wide range of different measures. Central Banks including the ECB have also joined the battle offering lending facilities at ultra-low interest rates and promising secondary market purchases of large amounts of corporate bonds as well as a significant proportion of the €1-1.5trillion government debt likely to be issued this year to pay for national European support programmes. Banks so often blamed for past crisis are now seen as part of the solution to this one and have been enlisted by national authorities to channel some €1.5trillion of Eurozone government guaranteed lending to where it is needed, fast. To help them do this, the flexibility built into the prudential regulatory framework has been triggered allowing banks to draw down on their substantial capital and liquidity buffers. These had been built up after the last financial crisis against such an eventuality as we are now facing. Recognising that scarce human resources might be needed elsewhere banks have also been allowed to postpone certain other obligations and pragmatic solutions have been found to permit markets to continue functioning in the new lockdown environment. More recently the European Commission has sought to provide banks with additional lending capacity by introducing targeted changes to the existing Capital Requirements Regulation. These are a mixture of substantive and timing changes. Amongst other measures, substantive changes have been made to ameliorate the capital impacts from IFRS 9 which governs the accounting treatment of provisioning for prospective credit losses and also allow the exclusion of banks’ holdings of Central Bank deposits from their leverage ratio exposure measure. The EC has also sought to bring forward beneficial measures including the application of favourable capital treatments for software assets and SME and infrastructure lending which were originally slated to come into force next June. The question is are these changes going to be sufficient to furnish banks with enough capacity to provide the support to their customers that is going to be needed in the coming downturn, let alone the recovery? We are not so sure that they will. According to ECB statistics, demand for funding in March - before the full severity of the economic downturn has been felt - was already at a record high with non-financial corporations borrowing nearly €120bn, more in that month than the whole of last year and higher than at any time in the last twenty years. ECB lending surveys point to similar very strong demand in the coming months. Net lending to euro area corporates (EURbn) Source:ECB Euro area statistics: BSI.M.U2.N.A. A20.A.4.U2.2240.Z01.E The ECB has estimated that banks using their capital buffers and changing the capital composition of their so-called pillar 2 requirement will free up €120bn of capital, enough to support €1.8 trillion of additional lending. Yet a quarter of this depends on the banks managing to issue new AT1 or T2 debt instruments and despite a few banks recent foray into the market this will take some time. Moreover, it is far from clear whether this lending capacity is truly new or includes substantial committed facilities which will need to be fully capitalised once they are drawn down and come onto banks’ balance sheets. Banks may also be unwilling to fully run down their capital buffers for fear that this could trigger restrictions in making payments on their AT1 debt which could cause a significant disruption in this market and negatively impact on the availability and pricing of future capital raising. A recent BIS bulletin from the 5thMay also raises questions on the reliability of the estimated lending capacity in the EU. It suggests that in a severe adverse (but in this case realistic) scenario releasing bank buffers would only generate between $1.1 and $2.6 trillion dollars on a global basis suggesting that the capacity figure in the Euro area may be overestimated. It is perhaps not surprising therefore that the ECB’s SAFE survey conducted between March and April this year and which covers expectations for access to finance in the Eurozone in the next six months is sending a significantly negative signal. Businesses expect a sharp decline in bank lending for the next 6 months Expected availability of bank loans according to euro area large firms and SMEs (for the next 6 months) Source:Source: ECB SAFE survey, Question 23. Net (increased minus decreased responses) - Excluding not applicable responses. Horizontal axis shows the month in which the survey was undertaken The other problem with relying on the ECB’s estimate is that it does not appear to take account of the fact that all the extra lending will only be possible if banks have sufficient capacity to finance it under both their non risk based leverage ratio measure and their risk based capital requirements. Whereas under risk based capital requirements banks are not required to hold capital against government debt (including the relevant portions of most government guaranteed loans) this is not the case for the leverage ratio measure which requires such exposures to be included at their full nominal value. As a result, banks wanting to make markets in government debt or advance government guaranteed loans may find that they have insufficient headroom in their leverage ratios to do so. In summary our concern is that the capacity available to banks in terms of capital headroom will be insufficient to meet the demand for it. The solution to this is to make further targeted and time limited changes to the EC’s CRR proposal. We have made several suggestions including ensuring that the benefit from an exclusion of Central Bank deposits from the LR exposure measure is effective now rather than in twelve months’ time. We also think that consideration should be given to the exemption of government guaranteed loans from the leverage ratio for a limited time. Both these adjustments have been made in several other jurisdictions and would strike an appropriate balance between providing banks with additional lending capacity and ensuring their continued robust solvency in the current stressed environment. Regrettably, the need for speedy legislative change and entrenched national positions has led to a reluctance to broaden the proposal currently on the table in the manner required. As has been the case during this crisis, EU Member States, while agreeing the common challenge have struggled to formulate solutions acceptable to all. The last time there was a crisis Europe was, by common consent, both late and timid in its solutions. Let us hope that history is not repeating itself.

While the EU might be embroiled in the struggle against Covid-19, there is another fight ramping up: the fight against money laundering and terrorism financing (AML/CFT). The EU AML/CFT framework has suffered from persistent deficiencies over a number of years, as highlighted by the European Commission last summer in their AML package. Whether it is a high-profile scandal or compliance failings, the EU has faced obstacles in capturing the illegal flow of money across Member States. This has in part been due to the difficulty of harmonising laws across different jurisdictions whose authorities have varying supervisory powers, tasks and responsibilities. However, in 2019, important steps were made to clamp down on the illegal activity. As part of the European Commission’s ambitious proposal to strengthen EU-wide Anti Money Laundering supervision, greater supervisory powers were given to the European Banking Authority (EBA). This has given the institution the power to lead, coordinate and monitor the AML/CFT efforts of all EU financial service providers and competent authorities. Since the expansion of the EBA’s responsibility, there have been important signs of progress. In February 2020, the EBA published a report on national authorities’ approaches to AML/CFT. The report indicated that most national authorities in the yearly sample were taking significant steps to strengthen their approach to supervision. However, the report also noted that not all countries were able to cooperate effectively with domestic and international stakeholders. This includes financial institutions, authorities and law enforcement. This inability to further harmonise the supervisory framework, both internationally and domestically, indicates that there is still work needed to improve how EU AML standards are applied. Currently, the EU’s approach to AML/CFT remains fragmented and struggles to keep pace with new developments, with a fifth version of a directive that acts more as guidance for EU Member States and which is far from being an enforceable rule. One option would be to replace (part of) the current Directive by a Regulation, which would set a harmonised, directly applicable regulatory and supervisory framework in the European Union. It could also give the EBA greater capacity to enforce harmonised AML standards. Additionally, steps need to be made to ensure that the responsibility for harmonising EU approaches does not fall solely on the EBA. Greater information sharing needs to be encouraged and facilitated amongst financial institutions, supervisory authorities and law enforcement authorities. To achieve this, developing a public-private ecosystem within and across Member States will be crucial. Technology could also provide the key to facilitating industry collaboration. For instance, strengthening the coordination mechanism for Financial Intelligence Units (FIUs) could be achieved with a proper use of a single digital system collecting, sharing and analysing information across Member States. This way FIUs could suitably support each other without duplicating their efforts. The EU’s collaboration internationally, domestically, and technologically will be crucial in the fight against money-laundering and the financing of terrorism. If no proper steps are taken now, the EU could find itself with another controversial list of money laundering scandals and the industry criticism that will accompany them. Read our discussion paper for further highlights on how industry collaboration can better strengthen and harmonise the EU’s supervisory framework in the AML/CFT space. AFME Contacts Richard Middleton Managing Director, Head of Policy [email protected] +44 (0)20 3828 2709 Hélène Benoist Manager, Advocacy +32 2 788 39 76 Aleksandra (Ola) Wojcik Senior Associate, Policy, Technology and Operations +44 (0)203 828 2734

The Capital Markets Union (CMU) project is still “not in the oven” - these were the words of José María Roldán, the President of the Spanish Banking Association (AEB), when opening AFME’s 11th Spanish Capital Markets Conference in Madrid on February 13. Roldán was one of many speakers to acknowledge that the CMU has not fulfilled its potential and further work is required to advance the European project. First introduced five years ago, the CMU project is still yet to see significant progress; as much as 88% of European funding comes from banks rather than Capital Markets. Pablo Hernández de Cos, Governor of the Bank of Spain, in his keynote address acknowledged the need toreinforce the European financial union amid growing industry risks and challenges. These risks include factors such as the deterioration in the global and euro growth outlook, as well as new challenges such as climate and technology risk. He also said the recent departure of the UK from the European Union has made progressing the CMU even more relevant. This is due to the need to accommodate the loss of the City of London and the important role it plays in financial services for the EU. At the conference it was also discussed how further investment could be attracted to Spain over the next decade. On a panel chaired by Editor in Chief of Bolsamania, Eduardo Segovia, it was agreed that it was too early to tell what impact the new Spanish coalition government would have on the markets; so far there had been no obvious immediate effect. However, Victor Rodríguez Quejido, Director General of Strategy and International Affairs at the Spanish National Securities Markets Commission (CNMV) said this outlook could depend on the government’s stance on Brexit and the impact this could have on market fragmentation. Rob Ford, Founding Partner and Portfolio Manager at TwentyFour Asset Management, added that the new government’s decision-making could potentially be hampered by coalition, and the lack of a clear majority. All panellists, despite the lack of certainty over the implications of Spain’s new coalition government, agreed that regulatory harmonisation and tax incentives would be key tools for attracting further investment in Spain and progressing the CMU. These were among the issues highlighted by José Manuel González-Paramo, Executive Board Director and Chief Officer of Global Economics and Public Affairs at BBVA. In his keynote address, he said the key to progressing the CMU would be harmonising rules in areas such as insolvency and tax, as well as harnessing technology change across the continent in areas such as blockchain. This was echoed by a call-to-arms by David Wright, Chair of EUROFI and Partner at Flint-Global, emphasising more strongly the need for a political ex-ante agreement and timetable to commit European authorities to the CMU project. It was clear from various interventions at the conference that if Europe does not commit more strongly to the CMU project soon, it is likely that five years from now, industry participants will be having the same conversation about how the CMU is not fulfilling its potential.

On 21 January, AFME and Simmons & Simmons hosted a panel session with the FCA to discuss in more detail some of the themes raised in our paper LIBOR Transition: Managing the Conduct and Compliance Risks. The session began with an audience survey, which concluded that 60% of attendees considered litigation risk to be the biggest compliance risk facing firms. Much of this relates to the challenge of identifying and transferring clients to replacement rates, particularly given the FCA’s statement that firms must not “move customers with continuing contracts to replacement rates that are expected to be higher than what LIBOR would have been, or otherwise introduce inferior terms”. The panel discussed the tension between the desire to pursue a broadly consistent approach and the complexities of meeting individual clients’ needs. No matter what a firm’s core market, their client base will contain a range of businesses, from sophisticated to simple, multinational to local, multi-banked to single-banked. Some clients are already well-sighted on their LIBOR exposure, others less so. Firms need to understand not only what products each client holds, but the underlying financing or investment need, in order to propose a suitable transition plan. As an example, the FCA was clear that LIBOR transition is an opportunity for firms to move customers to rates that are simpler and easier to explain. As such, firms will be coming under increasing pressure from the regulators if they continue to issue LIBOR linked products for new business. The timing of that transition is also key. Considering the size and scale of the project, it might be seen as prudent to begin transitioning continuing contracts as soon as possible, particularly as this approach offers transparency to clients. However, while LIBOR continues to exist, it is possible that client contracts that have already been transitioned may reference a rate which turns out to be higher than LIBOR. While noting the FCA’s recent letter to ISDA on the subject, it is also not certain at this stage whether LIBOR will promptly cease to exist at the end of 2021, or tail off as individual submitters withdraw. In the latter scenario, firms would be exposed to the risk of comparison between old and new rates beyond 2021 – compounded by the potential for LIBOR to become more volatile and potentially unrepresentative as the LIBOR panel shrinks. The FCA was clear that firms would need to make reasonable judgements in ensuring a replacement rate for LIBOR was expected to be as economically equivalent as possible at the time a decision was made. While a short-run risk of comparison was acknowledged, the FCA noted that firms would also need to consider the risks if client engagement and transition away from LIBOR is left very late and rushed through, or some clients remain exposed to a LIBOR rate that ceases to be representative after 2021. Over the last few years, industry groups, including ISDA and the Working Group on Sterling Risk-Free Reference Rates (RFRWG), have been engaged in helping to build market consensus on how individual asset classes can transition away from LIBOR. The FCA acknowledged the efforts of these UK working groups and encouraged firms to align with the market consensus to agree suitable alternative rates where appropriate. It was clear from the discussion that the ongoing nature of these important efforts makes the compliance challenges more complex – firms cannot wait for these discussions to conclude before acting. The FCA has also been clear that firms are not beholden to these market recommendations and are free to make their own commercial decisions about how and when to transition, although a departure from a ‘market consensus’ approach will need to be justified. More broadly, the FCA called upon firms to ensure that they have a comprehensive plan with intermediate deadlines throughout 2020-2021 – leaving too many key milestones until the end of the transition period will not be viewed well by supervisors. The panel also discussed the FCA’s expectations regarding firms’ communications with clients in relation to transition. Firms should expect the FCA to be looking for them to have produced clear communication strategies, which take into account different client and product types. System readiness was raised as a key dependency for firms’ transition plans, particularly against the backdrop of a market concern that system updates may not be ready in time to meet regulatory expectations on transition timeframes. The FCA encouraged firms to start preparing for the integration of system updates and clarified that a lack of system readiness should not be a reason for firms to delay LIBOR transition. Finally, the level of industry support for a legislative solution was discussed. While many in the room felt this would be helpful, the panel cautioned that it would be a complex process that might not bring the promised benefits. For instance, without a globally coordinated approach, firms would be under different legal obligations in each jurisdiction, meaning a ‘safe harbour’ in one might be outlawed in another. Legislators would also be faced with creating a solution tailored to the individual needs of each market and asset class, a tall order in the time left. The FCA’s parting message was that it expects to see an increase in the use of SONIA in the sterling derivatives market post March 2020, and will continue to monitor this closely. Evidently, the challenge facing compliance teams is huge and multi-faceted. The conduct issues discussed by our panel were only a few of those that firms need to consider and there are significant dependencies on the work being undertaken by market experts on the legalities and practicalities of the transition. The message, though, was clear: the danger of waiting is too great and firms need to start engaging with clients and mitigating the conduct risks now. AFME Contacts Richard Middleton Managing Director, Head of Policy [email protected] +44 (0)20 3828 2709 Fiona Willis Associate Director, Policy [email protected] +44 (0)20 3828 2739

Banks’ investment and trading activities are fundamental for the functioning of European capital markets. They assist governments, corporates and businesses to raise funds through the issuance of new securities and use their balance sheets to support these fund-raising activities by making secondary markets in the securities issued. This facilitates liquidity by lowering the borrowers’ initial funding costs in the process. Through their capital markets activities, banks also provide hedging solutions to a wide range of corporates and institutions, facilitating access to investment and saving opportunities across the globe which lowers risk through diversification. Banks which provide these important services are often amongst the largest, internationally active ones, as these are the players with the scale and resources required to access global pools of capital. Such scale is also needed to invest in the infrastructure, technology, trading expertise and risk management skills required to conduct such activities efficiently and soundly. Yet banks’ capital market capacity has decreased significantly since the crisis. As the EU prepares to reinvigorate its plans to develop the region’s capital markets via its Capital Markets Union (CMU) project, a closer look at how banks’ market intermediation and market-making functions are impacted by global regulatory initiatives will be key to ensuring the deepening of market-based financing in the EU. Banks have retreated from capital market activities - but does it matter? In January last year, a report from the Committee on the Global Financial System (CGFS) examining structural changes to the banking system following the crisis, observed that global banks had shifted away from trading activities[1]. In April 2018, AFME and PwC issued a report looking at how the balance sheets of 13banks, representing 70% of global capital markets activity, evolved between 2010 to 2016[2]. This study was able to quantify that these banks had reduced fixed income and equity assets by just under 40% during this period of post-crisis regulatory reform. Importantly, the study also looked at the reasons behind this reduction in capacity. It determined that changes to the prudential framework, and to risk-based capital requirements and the leverage ratio in particular, were responsible for about two-thirds of the explainable decline in capital market assets. Changes to prudential regulation were of course not designed by policy makers to be neutral in terms of impact, but to balance the requirement to strengthen the financial position of banks and the financial system against the need to preserve effectively functioning markets. In this respect it is legitimate to ask whether banks’ capital market capacity may have shrunk too far. Along these lines, the question also arises as to whether the EU has a banking system which, in addition to supporting direct lending to the economy, can also help improve the size and depth of its capital markets in line with the ambitions of its policy makers? At first glance, there may not be any visible cause for concern regarding the supply of financial services. Years of accommodative monetary policy have generally kept the cost of finance down and the non-bank sector, which operates without the same regulatory constraints that banks face, has stepped in to replace some of the capacity previously provided by banks. However, monetary policy and economic conditions can of course evolve, and the non-bank supply is untested and may not prove to be as resilient as that from banks in times of stress. Global dealer banks have in the past been able to use their large inventories of securities to help mitigate market volatility. But with shrunken levels of such assets, will they be able to do so in the future? The previously mentioned GCFS report also recorded worsening liquidity conditions in some market segments, particularly for assets which typically trade less frequently than others. Could this be an indication that banks are not able to provide liquidity as they were before, and that there are fewer alternatives for less frequently traded assets? Should we be concerned that banks’ post-crisis business model adjustments have given rise to capital market activities being increasingly concentrated in a smaller number of players, with European banks in particular having withdrawn from these businesses? A moving target: evaluating reforms while implementing further regulatory change More research needs to be done to answer these questions. Encouragingly, after a decade of regulatory reform, policy makers at both global and European levels have signalled they are shifting from rule-setting to monitoring and adjusting their reforms if necessary. In principle, this approach bodes well for the development of EU capital markets. We are however faced with a sequencing issue. Regulatory reform is in practice not yet finished andthe last piece of the prudential puzzle, known as the final Basel 3 agreement, is still to be implemented. With this critical aspect of reform outstanding, it is extremely challenging for policy makers and industry alike to evaluate the consequences of the full regulatory package. This is especially true in the context of banks’ capital market activities where there are multiple interactions between different parts of the regulatory framework and where prudential and markets policy makers often appear to work in silos without reconciling their objectives. In Europe, the process for implementing the final Basel 3 agreement will start with proposals from the European Commission for a 3rd Capital Requirements Regulation; possibly before summer next year. This will be followed by the usual negotiations between the European Parliament and Member States, which typically last two years. Therefore we are still a way off from knowing the final shape of the prudential framework and truly being able to assess how banks and their clients will ultimately be impacted. Especially in the context of depressed market valuations for European banks, uncertainty on the regulatory end-point is a significant challenge to manage and could lead to a further reduction in European capital markets capacity. It is therefore essential that this is carefully navigated. What might Basel 3 mean for European capital markets? A key feature of the final Basel 3 proposal is the so-called output floor, a measure designed to act as a backstop to capital requirements based on banks’ own estimates of risk weighted assets (RWAs). The output floor ensures that that internally modelled RWAs are not less than 72.5% of the corresponding amount calculated under standardised approaches for credit, operational and market risks. Contrary to previous rounds of regulatory reform where most market participants saw overall increases in capital requirements, the output floor is largely intended to capture outliers. This means it will affect banks unevenly, depending on their use of internal models and their type of business. Given the distribution of internal model usage, it is not surprising that initial impact assessments by the Basel Committee and European Banking Authority (EBA) show the output floor is likely to affect larger banks more than smaller ones and European banks more than their US counterparts[3]. The EBA’s work also shows that 7 of the 8 European G-SIBs in the sample analysed will be bound by the output floor instead of capital based on internal measures of risk. This move away from a risk-sensitive capital framework is undesirable because when regulatory capital becomes increasingly separate from underlying risk levels, this can lead to sub-optimal capital allocation decisions within banks and investments in riskier assets, rather thana safer system overall. Additionally, over recent years, many European banks have undertaken considerable efforts to improve their models under regulatory and supervisory programmes of the EBA and the European Central Bank (ECB) respectively. . It is understandable that the banks that have invested in these changes do not welcome the limitations the output floor places on the use of their models. Nevertheless, the output floor is a key part of the agreement reached between the members of the Basel Committee, and European authorities have repeatedly stressed their intention to implement it faithfully, placing a high weight on the importance of maintaining their credibility at the international negotiating table. While the output floor is likely to lead to overall increases in capital requirements for European banks, the final Basel 3 package includes other changes which will specifically affect their capital market activities. For instance, the new rules for calculating capital requirements for trading activities (known as the Fundamental Review of the Trading Book (FRTB)), will result in higher capital levels for market risk than today and becoming binding under the Commission’s CRR3 proposal. Banks will also no longer be allowed to model credit valuation adjustment (CVA) risk which reflects losses arising from changes in the credit quality of a counterparty to a derivative contract. Beyond the treatment of market risk, the final Basel 3 package also includes a new standardised approach for determining the capital that banks must set aside to deal with counterparty credit risk, or the risk of loss arising from a counterparty defaulting before it is able to meet its obligations under a derivative contract. Not only does this new approach intervene in the determination of the standardised output floor constraint, it is also relevant to several other areas of the prudential framework, leading to cumulative impacts on the availability and pricing of hedging solutions which have not yet been considered holistically by policy makers. Given that risk weighted assets for market risk make up a relatively small fraction of European banks’ total RWAs on average, the potential effects of these changes could appear to be comparatively small. However, as capital market activities are largely undertaken by of a relatively small number of large firms, these banks will be much more impacted than the average. Appreciating the extent to which these banks’ market activities have already impacted as shown above, the final parts of prudential reform must be implemented with caution if Europe does want to see banks support the growth of its capital markets. What should Europe do when implementing Basel 3? It is well known that the global regulatory community struggled to reach a final agreement on the Basel 3 package, and it will be important for all jurisdictions to implement it consistently and within the spirit of the agreement. This will be particularly crucial for the parts of the proposals which relate to global market activities where banks compete internationally. At the same time, the EU recognises that some of its banks will be the most heavily impacted by the proposals. European legislators should therefore ensure that their implementation of does not go beyond the intended impacts of the international standards. For instance, the output floor needs to be implemented as a true backstop measure. This can be achieved by basing its calculation on Basel minimum or Pillar 1 requirements and internationally agreed capital buffers rather than also including European and bank specific requirements as has been suggested by the EBA. Additionally, as with all Basel requirements which are calibrated at the group level, it is important that the floor applies to banks at a consolidated level rather than individual entity level to ensure that it does not distort or unduly impact specific businesses. It has already been stressed that that policy makers must reflect carefully on how the new changes to the prudential framework might further constrain banks’ market intermediation and trading activities. This should be done now, before the requirements are integrated into the rulebook. Without more joined up reflection between banking regulators, and those who wish to promote capital market development in Europe, there is the very real possibility that the reduction in capacity will continue. If this occurs, there is little hope that other CMU initiatives on their own can achieve the thriving capital markets Europe aims for and needs. The European economy will not benefit from the spare tyre function of having more developed market-based financing, nor it will it enjoy the much-needed private risk sharing and shock absorbing function that strong and integrated capital markets can bring. Beyond Basel 3, European policymakers should also examine how bank and market-based finance can be better linked. For instance, by enabling banks to make greater use of securitisation. In an economy that has been diagnosed with overbanking, banks need to be able to shift assets into capital markets. Not only will this reduce risk on their balance sheets, freeing up capacity, it will also provide investors with access to otherwise illiquid exposures. However, for banks to be able to engage in such transactions they need to make economic sense. This will only be the case if the cost of transferring risk to the market is translated into a commensurate reduction of the regulatory capital charge of the securitised assets. Policymakers should therefore also consider whether the rules governing regulatory capital relief, when risk is transferred outside of the banking system via securitisation, need to be revisited. Here, supervisory authorities, and the ECB, as the supervisor of the largest Eurozone banks, also have a key role to play to ensure that these rules can be operationalised as smoothly as possible. The new Commission and European legislators have a challenge to better integrate their approach to banking regulation and capital markets. By following the above recommendations, they can go a long way to building the capital markets Europe needs to retain a dynamic and sound economy. This article first appeared in Revue Banque on 10 January 2020 [1]Structural changes in banking after the crisis, 24 January 2018, Committee on the Global Financial System [2] Impact of Regulation on Banks’ Capital Markets Activities: Anex-postassessment, 12 April 2018, AFME & PwC [3] Basel III Monitoring Report, March 2019, BCBS and Basel III reforms: impact study and key recommendations, 5 August 2019, EBA

As Europe enters a new year it does so with a brand-new Commission, a long list of regulation to review, and a complex relationship with the UK. While the past five years have been focussed on getting post-crisis regulation delivered, the next political cycle will be ensuring the regulation is calibrated so it works for markets and citizens. However, the new Commission also acknowledges a number of new challenges. While the Juncker Commission focused on boosting economic growth and post-crisis reform, the von der Leyen Commission is taking office with a focus on wider social priorities such as climate change, technology and globalisation. This will have a clear impact for the future direction of Europe’s capital markets. The new Commission has already outlined grand plans to ensure Europe is carbon neutral by 2050 in its EU Green Deal. However, in order to achieve this target clear definitions of green finance and sustainable assets will need to be clarified through the EU sustainable finance taxonomy. This will deliver a universal standard of what is considered “sustainable” across the EU and mitigate “greenwashing” – labelling products as “environmentally friendly” without a means of verification. For the EU to remain globally competitive and at the forefront of innovation, the Commission has also identified that a focused digitaltechnology agenda will be vital for the next political cycle. FinTech is transforming capital markets by introducing platforms and servicing solutions; increasing competition with the intention of increasing efficiencies, enhancing risk management, lowering costs and improving services for businesses and investors. However, the future success will depend on the EU’s ability to prioritise investment and a culture of innovation across the industry. Innovation in particular is an area where Europe will look for improvement next year. In contrast to the US and Asia, Europe doesn’t have a single digital champion in the mould of Amazon and Google. In order to increase the chances that the next digital unicorn is from Europe, more investment in smaller entrepreneurial companies is needed. This can be achieved by progressing the Capital Markets Union (CMU) project, with hopes that the Commission’s High Level Forum can recommend concrete, consensus-driven recommendations to take forward. Reducing fragmentation and encouraging greater investment across borders will be critical in improving Europe’s global capital markets competitiveness and ensuring it does not fall behind other global markets. However, the CMU project faces its greatest challenge yet in 2020 with the departure of its largest capital market, the UK. Brexit means there is more urgency than ever to complete the CMU project to ensure it can deliver on its objectives of creating deeper, more integrated capital markets which can support growth and investment for the remaining EU Member States. Following the outcome of the UK general election, it appears clear that the UK will leave the EU on 31 January. The forthcoming negotiations on the future relationship and the adequacy and equivalence arrangements for financial services will have significant implications for European wholesale capital markets. It is critical that the EU and the UK work together to developa future relationship which supports financial stability and minimises fragmentation in wholesale markets, ensuring an effective and stable relationship for the future. Equally, Europe will have to ask questions of its engagement with the rest of the world. Financial markets are global by nature and to be truly transformative the CMU must embrace globalisation. By supporting interconnected markets, investment will then be unlocked both within the EU and the rest of the world to drive economic growth. As Europe embarks upon a new year it can look back on 2019 as a period where the groundwork has been laid for progress in 2020. Despite having made some advances on climate change, technology and globalisation, 2020 is the period when wider change is expected. Crucially, with the rise of citizen activism in Europe, change will not only be expected, it will be demanded.