Europe

Financial Measures Recently Introduced as a Result of COVID-19

 

Background and Context

On March 9 and 10, The Financial Policy Committee (“FPC“) met to discuss developments since its meeting on October 2, 2019 and the consequences of Covid-19.

Questions have arisen as to how the government, individuals and businesses can respond to the potentially devastating economic effects resulting from the expanding spread of the Covid-19 and the social lockdowns that are being implemented. In the summary and record of these meetings (available here), it is stated that:

“the FPC has taken action to respond to the financial stability risks associated with the economic disruption resulting from Covid‑19. These actions, taken in concert with actions taken by the Bank, the Monetary Policy Committee (MPC) and the Prudential Regulation Committee (PRC), have sought to reduce pressure on banks to restrict the provision of financial services, including the supply of credit and support for market functioning, and ensure that the financial system can be a source of strength for the real economy during this challenging period.”

The actions referred to above include the Bank of England’s (“BoE“) new Term Funding Scheme and the Covid Corporate Financing Facility.

Term Funding Scheme (“TFSME”)

Objective

This scheme was announced by HMRC on March 11 and seeks to ensure that the benefit of the cut in the bank rate is passed on to the economy. It aims to increase the availability of funding for banks which, in turn, will increase the amount available for lending, especially to small and medium sized enterprises.

By offering four-year funding at (or close to) the BoE’s bank rate, the TFSME seeks to “incentivize banks to provide credit to businesses and households to bridge through a period of economic disruption and provide additional incentives for banks to support lending to SMEs that typically bear the brunt of contractions in the supply of credit during periods of heightened risk aversion and economic downturn.”

Interest charged by the BoE will be equal to the bank rate plus a Scheme Fee, which is determined at the end of December 2020 based on the total net lending.

Eligibility

To qualify, the banks and building societies in question must be participants in the BoE Sterling Monetary Framework and signed up to access the Discount Window Facility. Further information on these tools is available here.

Participants will be able to make drawdowns during the Drawdown Period which will run from April 27, 2020 to April 30, 2021 and are to provide Net Lending Data in a form specified by the BoE on a quarterly basis.

Further information from the BoE is available here.

Covid Corporate Financing Facility (“CCFF”)

The CCFF aims to provide additional help to firms “to bridge through Covid‑19 related disruption to their cash flows.” It is to operate for 12 months and may continue as long as is required in order to help alleviate cash flow pressures.

Form of Assistance

Information made available by the BoE (here) explains that this is to take place by way of the purchase of short term debt in the form of commercial paper – an unsecured debt instrument issued by the company in question.

The commercial paper will be purchased under this facility (by the BoE through Covid Corporate Financing Facility Ltd) with the following characteristics:

  1. maturity of one week to twelve months;
  2. a credit rating of A-3 / P-3 / F-3 / R3 from at least one of Standard & Poor’s, Moody’s, Fitch and DBRS Morningstar as at March 1 2020 (where available); and
  3. issued directly into Euroclear and/or Clearstream,

Eligible Companies

It is explained by the BoE that to qualify under this facility, companies should be UK incorporated (including those with foreign-incorporated parents and with a genuine business in the UK), have significant employment in the UK or have their headquarters in the UK, although the BoE will also have regard to the amount of revenue generated in the UK and the number of customers based in the UK.

Importantly, and in addition to the above, companies wishing to benefit from the CCFF must demonstrate that it was in sound financial health immediately prior to the shock arrival of Covid-19. The BoE explains that the easiest way to demonstrate this is to have or acquire a rating which is either a short-term rating of A3/P3/F3/R3 or above, or a long-term rating of BBB-/Baa3/BBB- or above by at least one of the major credit ratings agencies.

Where the company does not have a credit rating, its bank should contact one of the major agencies to seek an assessment of credit quality. This should then be shared with the BoE and HM Treasury.

The names of issuers and securities purchased or eligible will not be made public.

Legislative Changes and Regulated Activities

With regards to the implementation of this facility, the Financial Services and Markets Act 2000 (Exemption) (Amendment) Order 2020 was published on 20 March 2020. This amends the list contained in Part 1 of the Schedule to the Financial Services and Markets Act 2000 (Exemption) Order 2001 such that Covid Corporate Financing Facility Ltd is exempt from the general prohibition contained in section 19 of the Financial Services and Markets Act 2000 (which prohibits the performance of regulated activities in the UK unless carried out by an authorized or exempt person).

Preparing for Brexit’s Impact on Capital Market Operations in the United Kingdom

 

Overview

The United Kingdom made headlines when it voted to leave the European Union in June 2016. Popularly named “Brexit”, the move began a tumultuous four-year voyage that seemingly came to completion on January 31, 2020 when the UK’s withdrawal became official. However, as many are coming to realise, the nation is just now beginning to face some of its biggest challenges yet.

While the UK may be officially out of the EU, the European Union Withdrawal Agreement Act of 2020 (EUWA) called for a transitory implementation period that will end on December 31st of this year. Until that deadline, the UK will largely be treated as a Member-state of the EU while trade negotiations are underway. However, the agreement period largely prevents an extension beyond the fast-approaching 11-month deadline, making this the country’s last chance at striking a satisfactory trade deal with the EU.

The EUWA currently provides that directly applicable and operative EU laws such as the Market Abuse Regulation, the Transparency Directive, and the Prospectus Regulation will be converted into UK law at the end of the year. However, this does not amount to a workable level of certainty, in that such regulation, once converted, would be exposed to domestic revision or amendment.

Impact on Capital Market Regulation

The potential failure to achieve a trade deal presents particularly significant issues concerning, firstly, the “passporting” system (i.e. the system that enables banks and financial services firms that are authorised in any EU or EEA state to trade freely with minimal regulatory oversight – thereby serving as the foundation of the EU single market for financial services) and, secondly, the creation of a new EU Capital Markets Union, of which the UK has traditionally been a strong supporter.

More specifically, the UK will no longer be a part of the EU’s single-market system and will be treated as a third-party country lacking passporting or equivalence rights in the EU. This could be detrimental to both the EU, who relies on UK’s economic activity to bring revenue into the EU, and for the UK, a hub for international transactions instigated by firms that capitalise on the minimal red-tape requirements made possible by the Capital Markets Union. Abdication of the passporting and equivalence practices in the UK could particularly affect instances where there are lower numbers of retail investors in more than one Member State, as individual approvals would be required in each such Member State due to the absence of said practices.

What Practitioners Need to Know

As it stands, the presumption is that the UK will be considered a third-party country at the end of the implementation period. Consequently, some UK firms with operations in the EU are relocating to EU member-states (or are considering doing so) in order to preserve their passporting rights. EU regulators and supervisors are monitoring this activity, and it is important for professionals at every level to stay updated on the various guidelines and resources released by authorities to assist practitioners during the transition period.

With the potential failure to achieve a free trade deal still on the table, businesses and their advisors need to be prepared to reckon with its consequences. For example, the European Central Bank has been pressuring banks to accelerate their Brexit strategy plans and implement a substantial portion of its policies by the time the withdrawal deadline occurs. If firms cannot rely on regulatory equivalence, firms may have to incur significant costs that could affect their financial stability, hence why they should be considering potential mitigating mechanisms to counteract such effects.

Furthermore, on February 4, 2020, the Statutory Auditors and Third Country Auditors published their regulatory amendments to address deficiencies of retained EU law arising from the withdrawal of the UK from the EU in relation to the regulatory oversight and professional recognition of statutory auditors and third country auditors in the UK. In addition to updating the adequacy standards of nations such as China and South Africa, the amendments also provided an assessment framework for the equivalence of third countries’ audit regulatory frameworks and enabled the audit exemption currently available to subsidiaries of UK and EEA parent undertakings to continue to be available to those subsidiaries where their financial years have already begun.

While players across the board are giving their best efforts to deliver a smooth and fair transition of the UK out of the EU, only time will tell how complicated and contentious the terms of such transition will be. With or without a free trade arrangement, it is especially important for financial professionals, attorneys, and other advisory professionals to be vigilant in their assessment of regulatory developments as they are released.

The Continued Rise of Sustainable Finance in the UK and EU

 

The present and future impacts of climate change, human rights violations, environmental, labor and regulatory violations and poor corporate governance on the quality of investments and credit risks have spurred widespread recognition for the importance of environmental, social and governance (ESG) considerations in lending and investment activities.

The rapid development of the sustainable finance sector seen in 2019 has continued into 2020. “Sustainable finance” is a very broad term, but in short, it is any form of financial service and/or product which integrates ESG criteria into business, financing or investment decisions. The financial markets are now starting to possess a range of tools in the “sustainable finance” space.

The value ascribed to robust ESG credentials also continues to grow. Companies and financial institutions are increasingly seeking ways in which they can conduct business in an environmentally-conscious manner and minimize ESG risks. Attention is coming from all sides – from activists such as Greta Thunberg; from regulators, with Mark Carney recently pronouncing on the integration of climate-related financial risks into day-to-to-day supervisory work of the regulators of the financial sector; and from investors such as BlackRock. Also, in the “BNP Paribas ESG Global Survey 2019” 78% of respondents stated that ESG is either playing a growing role or becoming integral to what they do as an organization (including in respect of what they investor in and/or who they lend to).

With the focus on sustainability and ESG only increasing, the appetite for sustainable finance products is set to continue to increase in 2020 and beyond.

Rise in Popularity of Sustainability-Linked Debt Products

There have always been compelling environmental reasons for sustainability-linked financial products and yet it is only recently that the economic rationale for such investments has come to the forefront. 2019 was a record year for sustainable finance, with more sustainable debt issued globally than ever before. The total raised was US$465bn globally, up 78% from US$261.4bn in 2018, according to Bloomberg data.

The key instruments from a pure financing perspective currently appear to be “Green Loans/Bonds” and “Sustainability-Link Loans/Bonds”.

It is important to know that “Green Loans/Bonds” and “Sustainability-Link Loans/Bonds” are different.

  • “Green Loans/Bonds” use the proceeds of such instruments to finance green projects or related capital expenditure (e.g. renewable power generation, carbon reduction and waste reduction).
  • “Sustainability-Link Loans/Bonds” do not have a dedicated use of proceeds and are not linked to green projects or green business (more flexible than “Green Loans/Bonds” but nevertheless, a good way for a company to demonstrate its ESG credentials). Rather, they include performance criteria linked to sustainability or ESG criteria/targets. Such criteria/targets can be measured by way of a general ESG rating or specific agreed criteria/targets. If the borrower hits the relevant sustainability or ESG criteria/targets, the loan will be cheaper. Recent deals have also adapted a two-way pricing structure, with the price of the loan increasing if the borrower fails to meet its ESG targets, further incentivizing the borrower to meet its ESG targets.

However, “Sustainability-Link Loans” are a relatively recent development in Europe. For example, it was reported that:

  • in May 2019, Masmovil Group, the Spanish telecom operator, was the first European borrower to include an ESG-linked margin ratchet in leveraged loan facilities, being a 15 basis point pricing adjustment linked to its third party ESG score (but noting that the pricing adjustment only applied to the capex and revolving credit facilities and not the much larger term loan debt); and
  • in December 2019, Jeanologia, a Spanish developer of eco-efficient technologies for the apparel & textile industry, completed the first sponsor-backed (Carlyle) ESG-linked term loan. The margin is directly linked to a sustainability performance indicator produced by the borrower, related to its water-saving processes. If the borrower meets its targets, the margin tightens, while if the target is missed by 15% or more, the margin ratchets upwards.

In addition, the Loan Market Association (LMA) published the Sustainability Linked Loan Principles (SLLP) in March of 2019, which provide suggested criteria for setting and monitoring sustainability targets of “Sustainability-Link Loans”. The criteria are meant to be ambitious and meaningful to the borrower’s business. The metrics vary and there is no market standard, from ESG scores (provided by third party ESG rating agencies) to borrower led / specific targets (as seen in the examples above). As such, the SLLP recommend they should be negotiated on a deal-by-deal basis. However, on a related point, the European Leveraged Finance Association (ELFA) has started, together with the LMA, to engage with borrowers, private equity sponsors, arrangers, rating agencies and others in order to develop a standard set of the most relevant disclosures for the purpose of making informed ESG-related investment decisions.

Legislative Change on the Horizon

There are many legislative changes on the horizon in relation to the development of robust sustainable lending products and sustainable finance more generally. These include: (i) the Taxonomy Regulation, which is expected to be formally adopted, introducing an EU-wide classification of environmentally sustainable activities; (ii) the Disclosure Regulation (main provisions coming in to force from March 2021), which will impose new transparency and disclosure obligations on certain firms; (iii) the Low Carbon Benchmark Regulation, effective as of December 10, 2019, which will continue to set out minimum requirements for EU climate transition benchmarks and ensure that these benchmarks can work alongside other pre-existing ESG objectives; and (iv) the development of technical standards by the ESMA on disclosure provisions for sustainable investments during 2020. From an investor/lender perspective, the Disclosure Regulation (noted at (ii) above) will be key, as it will require certain firms, including asset and fund managers, to comply with new rules on disclosure, as it regards to sustainable investments and sustainability risks.

Furthermore, it was reported this week that the current European Commission is prioritizing climate change in all sectors, including in financial services. An update to the law known as the “Green Taxonomy” would require banks, insurers, and listed companies with more than 500 staff members to report how much of their expenses are put towards environmental initiatives such as reduction of greenhouse-gas emissions. In a quest to widen its net, the European Commission is hoping to broaden the scope of the non-financial reporting even further in the legal proposal that is due by the end of 2020. The proposal likely seeks to cover asset managers, as well as large unlisted companies. Although some unlisted companies, such as Ikea, already do produce voluntary reports on sustainability, these new requirements may come less favorably to those companies seeking to avoid higher reporting burdens by staying off the public markets or to companies headquartered in more climate-skeptic countries.

Although changes to the regulatory capital treatment of sustainability linked debt are in contemplation at both a European and UK level, they are in their infancy. Currently, the focus of regulators appears to be on driving a conscious governance and disclosure framework and on integrating ESG risks into the management policies of regulated firms.

Recent Reports and Strategy Statements

Several reports and strategy statements have been published in recent weeks by a variety of prominent industry regulators and trade bodies in respect of ESG. Some highlights include:

The European Securities and Markets Authority (ESMA) published its Strategy on Sustainable Finance on February 6, 2020, setting out how ESMA will prioritize sustainability by embedding ESG factors in its work. The key priorities for ESMA include transparency obligations, risk analysis on green bonds, ESG investing, convergence of national supervisory practices on ESG factors, taxonomy and supervision. Steven Maijoor, Chair, said: “The financial markets are at a point of change with investor preferences shifting towards green and socially responsible products, and with sustainability factors increasingly affecting the risks, returns and value of investments. ESMA, with its overview of the entire investment chain, is in a unique position to support the growth of sustainable finance while contributing to investor protection, orderly and stable financial markets.”

The Investment Association (IA), the trade body that represents UK investment managers, published its Shareholder Priorities for 2020 report in January of this year. In the report, the IA noted its support for the recommendations made in the Green Finance Strategy released in early July 2019 by the UK government. Such recommendations set out two objectives: 1) to align private sector financial flows with environmentally sustainable growth that is supported by government action; and 2) to increase the competitiveness of the financial sector in the UK.

The UK Sustainable Finance and Investment Association (UKSIF) published a report on February 6. The report found that pension scheme trustees are failing to comply with their investment duties. Following a change to the law in 2019, trustees must publish their approach to protecting people’s pension savings from the financial risks of climate change and other ESG issues. UKSIF report: 1) found that only one third of a representative sample of trustees have complied with the legal transparency requirements and are calling for the Pensions Regulator to carry out a review to investigate levels of compliance across the UK’s pensions sector; and 2) looked at the different policies trustees have adopted to comply with the new regulations. It found that although most trustees say they believe ESG issues will affect the financial performance of their scheme’s assets, most trustees have adopted “thin and non-committal” policies to manage ESG financial risk.

Summary

In short, ESG is no longer a peripheral exercise thanks to investor demand, regulation and greater certainty about the link between ESG risks and long-term financial performance. And as noted above, the focus on sustainability and ESG is only increasing.

The EU’s Whistleblowing Directive

 

On November 26, Directive (EU) 2019/1937 of the European Parliament (EP) and of the Council of October 23 (the “Directive“) on the protection of persons who report breaches of Union law was published in the Official Journal.

Background

In light of recent information scandals including Cambridge Analytica, the Panama Papers and Luxleaks, the European Commission (EC) sought to introduce a unified measure granting protection to persons who report breaches of Union Law. These scandals have highlighted how crucial whislteblowers can be in uncovering unlawful activities, and the European Union (EU) has introduced the Directive to strengthen the enforcement of Union law and protect the freedom of expression of the whistleblower when interviewed on this topic, as explained by Maria Mollica, the EU Commission’s Policy Officer. While various Member States have addressed whistleblower protection in their own national legislation, the protection is often restricted to specific areas and thus the Directive attempts to unify and harmonize the approach taken by all Member States.

The Directive

Protection is afforded to whistleblowers to the extent they fall within the definition of “reporting person,” a natural person who reports or publicly discloses information on breaches acquired in the context of his or her work-related activities (Article 5(7)). In turn, this disclosure extents to information “including reasonable suspicions, about actual or potential breaches, which occurred or are very likely to occur in the organization in which the reporting person works or has worked or in another organization with which the reporting person is or was in contact through his or her work, and about attempts to conceal such breaches.” “Breaches” refers to any act or omission that is unlawful and relate to the Union or defeat the object or purpose of the rules in the Union (Article 5(1) and (2)).

It applies to businesses which employ at least 50 employees and they are required to implement internal channels to facilitate the reporting.

In terms of its scope, the Council of the European Union (EUCO) explains in a press release that “the new rules will cover areas such as public procurement, financial services, prevention of money laundering, public health, etc. For legal certainty, a list of all EU legislative instruments covered is included in an annex to the directive.” Further, regarding the protection awarded to reporting persons, it is stated that “the rules introduces safeguards to protect whistle-blowers from retaliation, such as being suspended, demoted and intimidated. Those assisting whistle-blowers, such as colleagues and relatives, are also protected. The directive also includes a list of support measures which will be put in place for whistleblowers.”

Next Steps

On November 26, the directive was published in the Official Journal and it will enter into force on December 16. Member States then have two years from that date to implement its terms and transpose its requirements into national legislation. Press Release. Legislative Text.

Securitization Regulation – Updates to the Questions and Answers by the European Securities and Markets Authority

 

On November 15th, The European Securities and Markets Authority (ESMA) published a new and updated version of its Questions and Answers in respect to the Securitization Regulation. 

The refreshed Questions and Answers provide direction on disclosure requirement in relation to ESMA’s draft technical standards, amongst other things. Questions and Answers.

 

Commission Delegated Regulation on Changing the Base Euro Amounts for Professional Indemnity Insurance

 

The Regulation varies the base amounts in Euros (see Article 10(4) as well as (6)) of the Insurance Distribution Directive) by 4.03%, i.e. the percentile changes in the index of consumer prices (Europe).

It should be noted that the Commission Delegated Regulation is coming into force on December 12. However, the Regulation will be operational and applied from June 12, 2028. As such, MS have half a year after its entry into force to adapt national legislation. Furthermore, the six months gives MS time to enable and allow insurance (and reinsurance) intermediaries and their insurance providers time to implement the steps necessary to ensure compliance. Commission Delegated Regulation.

The Position on Equivalence Post Brexit

 

Context and Background

On October 22, the House of Commons European Scrutiny Committee (the Committee) published its first report of session 2019/20 (the Report). In section 10, this includes consideration of the UK’s access to the EU financial services markets after Brexit and, more specifically, the European Commission’s recent review of the EU law on equivalence.

The notion of equivalence, and its importance in this context, was explained by the European Commission in a Press Release dated July 29 where it stated that:

“EU equivalence has become a significant tool in recent years, fostering integration of global financial markets and cooperation with third-country authorities. The EU assesses the overall policy context and to what extent the regulatory regimes of a given third country achieves the same outcomes as its own rules. A positive equivalence decision, which is a unilateral measure by the Commission, allows EU authorities to rely on third-country rules and supervision, allowing market participants from third countries who are active in the EU to comply with only one set of rules.”

However, the Report notes that, in light of Brexit, the financial industry of the UK will face a number of hurdles in relation to the provision of services to EU based customers. It is explained that the “current, automatic right of market access for banks, insurers and investment firms based on their UK-issued licence (known as ‘passporting’) will automatically fall away when EU law ceases to apply to and in the UK.”

Consequences

Where these rights fall away and, to the extent EU law ceases to apply in the UK, UK firms and business providing these services will have to comply with local regulations to access any of the EU’s national markets. Alternatively, the UK will need to apply for equivalence. Concerning the European Commission’s recent review of the use of equivalency, the Report notes on the one hand that “the EU would be wary of granting the UK equivalence in the most economically-important sectors (especially investment services) without safeguards that it will not substantially diverge from EU regulations.” On the other, however, it is stated that by not seeking equivalency, the UK runs the risk of seeing economic activity shift from the UK to the EU if UK firms are no longer able to provide services to their EU customers.

Equivalency is and has been addressed in the Political Declarations as annexed to the Withdrawal Agreements. Boris Johnson has indicated that parts of this document are to be renegotiated and it remains to be seen, whether equivalency is one of these points.

In the Report, the Committee asks the Economic Secretary to clarify, by October 31, if the government is seeking any changes to the sections of the political declaration related to financial services. He is also asked to confirm if the government is considering seeking equivalence under EU law post-Brexit and, if so, which specific pieces of EU legislation the equivalence is being prioritized under. In anticipation of the response, the Committee cleared the Commission’s equivalence review from scrutiny. Report. Press Release.

EBA Publishes Opinion on Eligibility of Deposits, Coverage Level and Co-Operation Between Deposit Guarantee Schemes Under the DGSD

 

On August 8, the European Banking Authority (EBA) published an opinion (EBA-Op-2019-10) on the eligibility of deposits, coverage level and co-operation between deposit guarantee schemes (DGS) under the Deposit Guarantee Schemes Directive (DGSD) (2014/49/EU).

The opinion outlines a number of general and specific proposals for the European Commission to consider when preparing its mandated report on the progress made towards implementing the DGSD and if the Commission prepares a proposal for a revised DGSD.

The opinion sets out the EBA’s proposals on a range of topics, including:

  • Home-host co-operation, and co-operation agreements between DGS
  • DGS’ co-operation with various stakeholders
  • Transfer of contributions
  • Coverage level
  • Current list of exclusions from eligibility and current provisions on eligibility

It includes a report that provides a detailed analysis of each topic, including the background, methodology, data sources, options to address the issues identified and conclusions.

EBA Publishes Feedback on Review of Single Rulebook Q&A

 

On August 6, the EBA published feedback following a review of the use, usefulness and implementation of its single rulebook Q&A.

The review was carried out in the second half of 2018 using questionnaires addressed to competent authorities and selected industry representatives. It was limited to Q&A relating to the Capital Requirements Regulation (CRR) ((EU) No 575/2013) and the Capital Requirements Directive (CRD) (2013/36/EU), which (at the time) accounted for about one third of final Q&A.

The EBA’s main findings include the following:

  • There are limited cases of non-application of Q&A identified by survey participants.
  • Competent authorities and institutions (to a slightly lesser extent) are, overall, satisfied with the utility of the single rulebook Q&A tool and the answers. However, they suggest various improvements relating to matters including response times, the search function and the presentation of the final answers.
  • There are similarities in terms of the measures taken by competent authorities at the institution level or by institutions internally to promote the Q&A tool and the use of answers.
  • Competent authorities use regular or ad hoc measures to encourage the use of the Q&A tool internally.

Based on its review, the EBA has provided non-prescriptive good practice guidance that institutions could adopt with respect to the use of Q&A (see chapter 4).

In addition, the EBA will consider the comments and suggestions received on the process, tool and answers, with a view to developing realistic and workable proposals for improvements. The EBA is also considering the reported cases of non-application in more detail to better understand the obstacles and issues in relation to the Q&A. It expects follow-up actions to be limited to informal exchanges and ad hoc queries to relevant competent authorities.