Regulation of the European financial services industry
June 2019 | EXPERT BRIEFING | BANKING & FINANCE
A decade after the start of the global, yet quintessentially European, political, social and legal race to find the real culprits of the financial crisis, the current landscape is paradoxically opposed to where the prevailing winds were supposed to be taking European financial infrastructure.
Today, generally speaking, we observe, from north to south, a European banking sector with quote prices that are far below their book value and returns on equity that are unsustainable given the current costs of capital – but, surprisingly, with efficiency ratios that differ and where some players, based in southern countries, beat their northern neighbours by far. Perhaps this is because the short, medium and long-term response was driven by certain moral and social cohesion factors, rather than by practicality, determination of costs and classification of the waterfall of payers.
As to the current financial services landscape, the reality for more or less the entire range of players, irrespective of whether they are credit institutions, payment entities or investment services firms, is that it is now extremely challenging. In the monetary field, negative interest rates are undermining the ability of banks to conduct their business.
In the field of international politics, we have global players but they are locally labelled. We have US protectionism, harsh sanctions against foreign banks and extraterritorial regulations designed to protect their interests, and Southeast Asia as a decoupled specialised competitor. These two regions compete with the financial services industry of the old continent that has China in the rearview and a pending divorce from the UK – a major player in the financial services industry that is expected to be a fierce and knowledgeable competitor.
In the political field, financial institutions, particularly banks, have been blamed for the turmoil and used by politicians as the last bastion of defence against a weary population. To sum up, certain sovereigns have been accused of being tax havens, obliging those usually very small countries that flourished thanks to the financial services industry to adopt reporting and regulatory standards that have erased their competitive advantage and jeopardised their sustainability.
However, the perfect storm is the regulatory field. A gigantic spider’s web of regulation has been set up, with worldwide effect, and in some jurisdictions with temporary vocation, but with European bureaucracy leading and being whiter than white.
Although the US took the lead with the Dodd-Frank framework, in Europe things have been slow but unrepentant. The Larosiere Report represents the starting gun that led the current regulatory framework. The European System of Financial Supervision (ESFS) composed by the European Systemic Risk Board (ESRB) and its three supervisors – the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA) – were created with supervisory and regulatory attributes to issue recommendations, rules and guidelines. The financial crisis also led to the creation of the Single Supervision Mechanism (SSM). In this context, certain southern countries, such as Spain, substantially modified their local regulations to adapt financial assistance from the European Financial Stability Facility. Spain, in fact, was one of the first countries to adopt a harmonised banking resolution framework in 2012, which the EU implemented later through the Banking Resolution Directive.
Yet the restructuring of the sector necessarily implied the use of hybrid capital instruments issued by banks, such as perpetual subordinated debt or convertible bonds, to improve the upper parts of their frail balance sheets. Capital instruments with inherent risks – that added to an increasing wave of litigation against financial institutions – largely due to perceived misselling to unsuitable investors during the crisis, led to the adoption of harder measures in terms of investor protection and with a general reversion of the burden of proof toward financial institutions.
Between 2013 and 2017, we had, among others, the Capital Requirements Directive (CRDIV), the Capital Requirements Regulation (CRR), the Recovery and Resolution of Credit Institutions and Investment Firms Directive (BRRD) and later, the Market Abuse Directive (MAD) and the second Markets in Financial Instruments Directive (MIFID II), as well as a long list of delegated regulations of executions, including the process of implementing the European Market Infrastructure Regulation (EMIR).
In terms of reviewed documents, paperwork involved, working groups, new hires, and external legal and financial advisers, the workload has been enormous and costs excessive for most of the small and middle players in the market. In parallel, other competitors in the financial sector have appeared with dominant positions in the web retail industry or IT universe, most of them with undefined regulatory environments that give them the appearance of being fresh, different and flawless.
Nevertheless, is the EU financial system better supervised and more transparent and sounder now? Probably, although it still lacks a European deposit protection scheme. Are investors and depositors more protected and is the information provided to them clearer in contractual and pre-contractual phases compared to years ago? Probably, at the expense of a certain downgrade in freedom and some social considerations. But, has the regulatory avalanche enhanced business and made more profitable financial institutions? Surely not. And has the EU and more specifically its Member States enhanced global and cross-border integration and concentration of financial undertakings rather than protecting and promoting their own national players? Again, surely not.
While smaller entities play in smaller leagues, monetary policy is affecting all financial institutions and the odds do not favour German and French banks. Southern institutions, especially Spanish banks, are showing strong resilience to the regulatory avalanche. They have sound and flexible IT infrastructure, long-lasting experience in concentrations, as well as a geographical diversification that can be decisive in determining their controlling role in future cross-border concentrations. This, together with the previous concentration of the clumsy German banking sector, is the key to the vault of understanding this cold interwar period.
Miguel Cases is the managing partner at Cases & Lacambra. He can be contacted on 0034 93 611 92 32 or by email: firstname.lastname@example.org.
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