Discussion on the current Regulatory Reform Agenda of the European Financial Sector and its Compatibility with Growth and Jobs Creation Objectives.

Interview with KPMG Advisory Belgium.

October 2014

[Banking Boulevard]: The European Financial Sector regulation is subject to significant evolutions, how would you describe the current status?

[KPMG Advisory]:

Wide-ranging EU measures have been completed since 2009. These cover all sectors of financial services. The unrelenting pressure for more regulatory reform shows no sign of abating. We see four main drivers of this in Europe:

First, recently enacted EU legislation requires a massive number of technical standards to be developed by the three European Supervisory Authorities (ESAs) – the EBA, EIOPA and ESMA. Some Regulations and Directives in the financial sector require more than 100 such standards to be developed. In addition, the ESAs are developing voluminous supplementary guidelines for national competent authorities.

Second, there is a substantial pipeline of unfinished EU business – already proposed financial reform measures – for the next Commission and Parliament to grapple with.
These include:
-a structural separation of banks,
-regulation of money market funds and other elements of ‘shadow banking’,
-regulation of financial benchmarks,
-strengthened regime on anti-money laundering,
-resolution of clearing houses,
-financial transactions tax,
-investor compensation schemes,
-second insurance intermediation directive on the sale of insurance products, long-term investment funds and occupational pension funds.

Third, the EU will be under pressure to respond to the even longer list of unfinished business in the setting of international standards by the Financial Stability Board (FSB) and the three international sector-based standard setters (the Basel Committee, the IAIS and IOSCO):

• For banks, this includes what KPMG has called the ‘Basel 4’ agenda which consists i.a. in:
-finalizing the minimum leverage ratio;
-constraining the internal model-based approach to calculating capital requirements;
-tougher limits on large exposures;
-setting minimum requirements for gone concern loss absorbing capacity;
-and higher standards of risk data aggregation and reporting.
• For insurers, just as the EU has finally reached agreement on the implementation of Solvency 2, there is significant movement at the international level on introducing a basic capital requirement, capital surcharges, recovery and resolution requirements and more intensive supervision for systemically important insurers; and on introducing international standards for a more sophisticated capital framework that will apply to all internationally active insurance groups.
• There has been a surge in outputs from the FSB on risk governance.
• The FSB is developing its five work streams on shadow banking, covering:
-money market funds,
-repo and securities lending markets,
-the connections between banks and shadow banks,
-the identification of other non-banks that potentially pose systemic risk,
-and securitisation.
• The FSB is also pushing forward on the consumer agenda, some aspects of which could extend beyond the existing and proposed EU legislation and the consumer issues being taken forward by the ESAs.

Fourth, the European Central Bank is taking an understandably risk-averse approach, initially in the context of its Asset Quality Review and its joint stress test with the EBA, but also probably thereafter in both its supervisory activities and its input to regulatory developments.

[Banking Boulevard]: What are your views on this agenda in the context of the European economic crisis ?

[KPGM Advisory]:

The current regulatory reform agenda is overly-focused on the single dimension of promoting ever-greater safety and soundness, in the hope that – at some point – this will begin to facilitate financing and growth. This ignores the strong likelihood that ever-greater regulation has taken Europe to a position in which further safety and soundness is being bought at the expense of growth, both now and over the longer term.

It is time to switch to a second dimension, in which finance is viewed as a facilitator of jobs and growth, alongside greater competition, competitiveness and innovation. This requires the promotion of long-term financing, of capital markets and an equity culture, and of alternative channels of financial intermediation.

To achieve this, a much clearer and more detailed EU vision is required.

KPMG developed a series of specific proposals for encouraging and facilitating the contribution of the financial sector to jobs and growth in the wider economy.

[Banking Boulevard]: Which measures are you suggesting to facilitate jobs creation and economic growth?

[KPGM Advisory]:

As mentioned earlier, KPMG developed some very specific proposals to achieve this goal.

First, we suggest to focus on developing EU Capital Markets. We identified a series of potential action points in this field, namely:

• The Commission should consider why the EU is so different from the US in terms of the size of its capital market and why so many European companies source finance through the US market. The US has been so much more successful in developing an equity culture among both investors and corporations.
• Consider to what extent capital markets in the EU are being constrained by legislative or regulatory restrictions. It is unlikely that an effective capital market can be created simply through additional legislation and other government interventions.
• Ensure that any moves towards a ‘capital markets union’ focus on creating a genuine single market, with deeper and more liquid European capital markets that meet the needs of companies wanting to raise funds and of investors.
• Remove the preferential tax treatment of interest payments relative to dividends. Current systems of tax relief on interest payments favor the issuance of debt over equity as a means of funding businesses (including the funding of banks).
• Develop a private placements market, making it easier to fund finance within Europe.
• Remove trade barriers and take a more global approach to the EU financial sector – many financial institutions and their customers are global, not confined to the EU.

Second, we believe that the commission road map for long term financing needs to be strengthened to meet the needs of the European economy. This road map does little more than to repackage a number of initiatives that are already more or less in progress, with too much emphasis on the ‘solution’ being more official intervention, not less. The road map needs to be based on more specific and detailed proposals on changes to the regulation of banks and insurers; how European capital markets could be developed; what is really meant by “better use of public funding”; and the extent to which the availability of greater information on infrastructure investment plans would attract more private finance to infrastructure investments.

Third, KPMG would focus on encouraging insurers to provide more long-term funding for infrastructure investments. Although Solvency 2 has been helpful in lifting some restrictions on long-term infrastructure investment by insurance companies, this could be taken further by reducing the high capital charges applied to longer duration and lower rated investments, and to unlisted equity.

Fourth, we would deem supporting asset managers to invest more in infrastructure by implementing the proposals for European Long-term Investment Funds (ELTIFs) and by increasing the supply of funds.

Our fifth, proposal consists of promoting bank lending to SMEs and infrastructure. In this context one simple improvement here would be to treat high quality securitisations in the same way as covered bonds in capital and liquidity requirements for banks.

[Banking Boulevard]: How can the regulatory reforms agenda be adapted to be compatible with the growth and jobs creation measures that you just mentioned?

[KPGM Advisory]:

Waves of regulatory reforms have been introduced since the financial crisis, to make financial institutions safer, to make the financial system more stable, and to shift the costs of failures from taxpayers to the creditors of, and shareholders in, failing institutions. Seven years after the financial crisis began, the flurry of EU legislative activity on financial services in April this year was not the end of the road for regulatory reform but merely an artificial break point necessitated by European Parliament elections and the appointment of a new Commission.

The Commission’s comprehensive review of the financial reform agenda, published in May this year, claimed that the benefits of the regulatory reform measures introduced since the financial crisis will far exceed their costs.

However, KPMG’s financial sector regulation experts have argued that the relentless introduction of more and more regulation may already have taken many economies, especially in Europe, beyond the ‘tipping point’ to a position where the costs of regulation exceed the benefits.

The introduction of more and more regulation has increased the cost, reduced the availability of financial services and reduced innovation in financial services. Its negative impact on economic growth has been seen most powerfully and immediately in the downward spiral of bank deleveraging and weak or negative economic growth in Europe over the last few years. Banks have exited many markets, shrunk their balance sheets, sold capital- and liquidity-intensive assets, and pulled back from the provision of risk management services to their customers.

KPMG believes that three actions are required to deliver regulatory reforms that are compatible with the jobs and growth agenda, namely: halting some proposals; rebalancing some existing regulations; and providing greater certainty.

KPMG sees following action points as important steps in order to call a halt and provide greater certainty:

• The EU legislative proposals on banking structural separation should be dropped;
• The long-running and confused proposals for a Financial Transactions Tax should be dropped;
• A cap should be placed on the cumulative impact of the multiplicity of additional capital requirements;
• The Enhanced Disclosure Task Force proposals for greater disclosure and market discipline should be adopted;
• Put in place a clear prioritisation of what needs to be done in order to provide a more certain environment, or alternatively, call a pause to the regulatory reform agenda;
• Clarify the division of responsibilities and achieve greater global consistency.

With respect to rebalancing and recalibration, one should take a proportionate view and focus on the cumulative impact of regulation. It is crucial to take a broader view of where regulation needs to adjust to market realities.

[Banking Boulevard]: How do you guide banks through this complex and constantly changing regulation tangle?

[KPGM Advisory]:

At KPMG Advisory, we have invested years into helping organizations meet not only the challenge of today’s risk-filled business world, but also improve their performance and enhance their growth. We are able to turn a challenge like enhanced regulations into a competitive advantage for our clients.

KPMG's teams work hand-in-hand to bring integrated, multidisciplinary, and cross-functional knowledge and skill sets to get the job done. The result is that we offer not only transformation strategies in order to be able to comply to all European financial regulations, but the strong capability needed to execute those strategies and deliver sustainable change that drives business performance.

Contact KPMG Advisory: Koen De Loose, partner. Tel: +32 (0)2. 708.43.17 kdeloose@kpmg.com