Balancing risks and open markets

Regulators continue to assess pandemic impacts and risks, and approaches to cross-border issues are changing and developing.

ESMA's latest risk assessment remains at very high, across its remit. Valuations in EU financial markets remain sensitive to events and volatility, as shown by the market movements related to Gamestop and the impact that a potentially slow roll-out of vaccines had on equity prices. Increasing corporate and public debt levels are likely to heighten credit risk. ESMA expects a prolonged period of risk to institutional and retail investors of further — possibly significant — market corrections.

The EBA's quarterly risk assessment showed that profitability of EU banks improved strongly in Q1 2021. Return on equity increased, driven by declining cost of risk and rising fees, commission and trading income. CET1 ratios increased slightly, and the leverage ratio contracted quarter-on-quarter. Non-performing loan (NPL) ratios declined, despite a slight rise in NPL volumes, but many banks expect the asset quality of most portfolios to deteriorate and foresee an increase in operational risk.

EIOPA emphasises that the pandemic crisis is still not over. Many uncertainties remain and some negative effects might become visible only when pandemic measures are phased out. Some lessons learnt have already been reflected in the Solvency II review, but it is essential to keep the focus on new emerging risks, such as cyber and climate risk. EIOPA is currently running an EU-wide insurance stress test exercise assessing the impact of an adverse COVID-19 scenario in a “lower for longer” interest rate environment on insurers' capital and liquidity positions.

In the April edition, we noted that the EU and the UK had agreed the text of the Memorandum of Understanding (MoU) that creates a framework for voluntary regulatory co-operation on financial services. The EU Financial Services Commissioner, Mairead McGuinness made it clear in a speech in London in June that “Once the MoU is formally concluded, we will have to consider whether we can resume our financial services equivalence assessments….and on a case-by-case basis, taking into account the UK's regulatory intentions and of course the EU's interest.” She also emphasised that the EU's strategy was towards “Open Strategic Autonomy”, which was demonstrated by ESMA's announcement that its fourth annual stress test of central counterparties (CCPs) will include the two UK CCPs (which are Tier 2 CCPs under EMIR).

The Commission continues to undertake equivalence assessments of the CCP regulatory regimes in third countries such as the US, China, Israel and Malaysia. Therefore, it has extended for a further year the transitional regime under the Capital Requirements Regulation (CRR), allowing EU banks and investment firms to have lower capital requirements for exposures to “qualifying” CCPs recognised by ESMA.

There was a 31% increase in the value of assets held by incoming third-country branches in the EU between 2019 and 2020. The EBA found divergent regulatory and supervisory approaches to such branches across member states and recommends that further harmonisation is needed. It proposes quantitative thresholds and qualitative criteria that, if exceeded, would require the branch to convert to a subsidiary.

The UK is looking further afield. It has agreed a financial partnership with Singapore, backed by an MOU that aims to reduce frictions for firms serving UK and Singapore markets by recognising that each other's financial services regulatory regimes achieve similar outcomes.