Coronavirus response: How the Capital Markets Union can support Europe’s recovery

This article is brought to you in association with the European Commission.

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What is in today’s Capital Markets Recovery Package? Today’s package contains targeted amendments to the Prospectus Regulation, MiFID II and securitisation rules. All of the amendments aim to help financial markets support Europe’s recovery from the coronavirus crisis. They are at the heart of the Capital Markets Union project aimed at better integrating national capital markets and ensuring equal access to investments and funding opportunities across the EU. The package includes:

• A new “EU Recovery Prospectus” – a type of short-form prospectus – to facilitate the raising of capital in public markets.
• Improvements to MiFID II to encourage investment in the real economy and free up resources for both firms and investors.
• Improvements to the securitisation rules to support SME lending and the management of non-performing loans.

How will the Capital Markets Recovery Package contribute to the EU’s recovery from the coronavirus crisis?

• Today’s package introduces a shorter prospectus for well-known issuers. The aim is to facilitate the recapitalisation of companies affected by the economic shock of the coronavirus pandemic. This new short-form prospectus will be easy to produce for issuers, easy to read for investors and easy to scrutinise for national competent authorities. The alleviated prospectus rules will enable companies to issue capital more easily and, therefore, reduce their debt-to-equity ratios, thereby helping them stay solvent.
• The proposed changes to MiFID II will contribute to Europe’s recovery by facilitating investments in the real economy and freeing up resources for both firms and investors. Disclosure and information requirements for transactions between professionals will be streamlined. Complex requirements that have proven a hindrance to the prompt execution of investment decisions will be simplified. The coverage of small and medium size companies by research analysts will be improved. And nascent euro-denominated energy markets will be promoted.
• Amendments to the securitisation framework will increase banks’ capacity to provide loans to households and companies by extending the simple, transparent and standardised securitisation to on-balance sheet securitisation which is mostly used for corporate loans, in particular SME loans, and by facilitating the securitisation of non-performing loans.

What are the next steps? It is now for the European Parliament and the Council to agree to today’s legislative texts. After the package is adopted and has entered into force, the changes to the Prospectus Regulation and the Securitisation Framework will apply directly in the Member States. The MiFID amendments will need to be transposed into national laws before they are applicable. In parallel, the Commission has opened today a public consultation on amendments to the MiFID II delegated Directive on the regime for research on small and mid-cap issuers and on fixed-income instruments. LEGISLATIVE PROPOSALS What legislative changes has the Commission proposed today? The package contains amendments to the Prospectus Regulation (EU) (No 2017/1129), the Markets in Financial Instruments Directive (2014/65/EU), the Securitisation Regulation (EU) (No 2017/2402) and the Capital Requirements Regulation (EU) (No 575/2013). It also contains a draft delegated Directive amending MiFID II delegated Directive (EU) (2017/593) on research. The Commission will adopt this delegated Directive after the expiry of the Better Regulation consultation. Prospectus Regulation More information about the proposed Prospectus Regulation is available by clicking on the subtitle above. An explanatory memorandum is also available. Why create a new type of prospectus? The severe economic repercussions of the coronavirus pandemic calls for a rapid introduction of measures to facilitate investments in the real economy, to allow for a rapid re-capitalisation of EU companies and to enable issuers to tap into public markets at an early stage in the recovery process. That is the reason why we propose to create the EU Recovery Prospectus. This short-form prospectus aims to be easy to produce for issuers, easy to understand for investors and easy to approve for national prospectus authorities. What are the main features of the EU Recovery Prospectus? In order to be an efficient tool that effectively supports the recovery of listed companies, the EU Recovery Prospectus will be a single document, of only 30 pages, focusing on essential information that investors need to make an informed decision. It will be available for issuers that have been listed for at least 18 months and want to issue shares. The EU Recovery Prospectus will benefit from the EU passport mechanism, meaning that all investors from the EU will be able to finance these companies if they wish to do so. This new short-form prospectus will be easy to produce for issuers, easy to read for investors and easy to scrutinise for national competent authorities. What are the other measures you propose? We are also proposing two other sets of targeted amendments to relieve pressure on financial intermediaries (such as commercial banks or investment banks):

• The first one relates to a document known as a “supplement”, which is a supplemental document to a prospectus that must be published, under certain conditions, when a significant new factor, material mistake or material inaccuracy relating to the information included in a prospectus arises. Financial intermediaries should contact investors when the supplements are published. The proposed amendments clarify the scope of investors that should be contacted as well as when they should be contacted.
• The second set of amendments aims at supporting credit institutions. These institutions have been active in supporting companies that needed financing during the coronavirus. They are expected to be a fundamental pillar of the recovery phase. In order to help smaller credit institutions, we propose to make it easier to raise additional funds on a regular basis without the necessity of issuing a new prospectus each time the bank raises additional funds.

How will the proposed measures ensure investor protection?

• The EU Recovery Prospectus will focus on the essential information – including risk factors – that investors need to make informed decisions. In addition, the EU Recovery Prospectus will only be available for issuances of shares and for listed issuers that already have an 18-month disclosure track record on capital markets.
• We propose to extend by one day the deadline for the financial intermediaries to contact investors when a supplement to a prospectus is published. In parallel, in order to protect investors and their rights, we extended by one day the deadline for investors to exercise their withdrawal rights when a supplement is published.

MiFID II More information about MIFID II is available by clicking on the subtitle above. A memo is also available. Why are you proposing changes to the MiFID regime? And why are you proposing these changes when the normal review process is planned to take place next year? MiFID II sets out rules for investment firms that are active in the EU’s financial markets. These rules dictate how investment firms should interact with investors and how they should organise the markets where the trading takes place. Some targeted amendments to the current regime could already now improve access to financial instruments for investors and free up issuers’ resources that can be better addressed to their core business. These objectives have become even more important following the coronavirus pandemic. In order to contribute to the recovery, today’s amendments need to enter into force as soon as possible and cannot wait for the more in-depth MiFID review. What are the main features of the MiFID II amendments? There are three main parts to today’s amendments:

• First, new rules will mean that the level of information provided to clients, in particular professional clients such as large corporates and financial institutions, will now be more targeted to their needs. They will receive fewer automated mandatory disclosures. Information will no longer be provided on paper, except if retail clients specifically request so. Furthermore, investment firms will no longer have to perform certain types of assessments – called “product governance” – for certain types of products, since these products can be considered suitable for all types of clients, including retail clients.
• Secondly, today’s amendments contain changes to derivatives rules for which the underlying value is a commodity, such as gas or electricity. These derivatives are important for companies whose primary business is in these commodities, in order to obtain cover against risks. The changes ensure that euro denominated EU commodity markets can grow so that the real economy is in a better position to shield themselves from future risks in commodity price movements. The changes will not affect agricultural commodity products, in particular products used for human consumption.
• Finally, rules guiding the provision of research on small and mid-cap companies and on fixed income instruments will be partially revisited. The exceptional circumstances resulting from the coronavirus pandemic have instilled a sense of urgency into the debate on investment analysts’ research. Increasing the visibility of European companies, in particular SMEs, to investors will promote more investment for the economic recovery.

Increasing investor protection was one of the key objectives of MiFID II. How will you ensure that the proposed amendments will not weaken protection? Today’s package contains targeted alleviations to investor protection measures that have already been deemed to be of no use or even detrimental to investors. The alleviations mostly apply to professional investors when they deal with each other in a business-to-business relationship. These investors typically have experience and knowledge of the financial markets and the instruments they deal in and are capable of obtaining relevant information themselves. They often negotiate bespoke relationships among themselves and derive little if no use out of standardised disclosure forms. The Commission is proposing only limited alleviations for lesser-experienced investors, who can always choose to be fully protected if they so wish. The proposal tries to achieve a shift from paper-based information disclosures to electronic information disclosures. This is great for the environment, but what if I don’t have easy access to electronic information? The current standard is that investment firms need to provide all client information on paper, unless the client requests to receive it electronically. The proposal aims to decrease the amount of paper that investment firms use in their communications with clients. The coronavirus pandemic has made the use of online services even more common and this amendment will allow a faster flow of investor communication. We realise there might be retail clients who do not have easy access to electronic information. For those clients, the amendment contains the option to receive information on paper. What are the proposed changes regarding the provision of research by third parties? Research has an important role to play in informing views on issuers, financial instruments or assets. It ensures the increased visibility for issuers and, in turn, a sufficient level of investment and liquidity. Research on small and mid-cap companies and on fixed income instruments, has experienced a decline in research coverage for several years. The short-term measure we propose to incentivise the production of research on small and mid-cap companies and on fixed income instruments is a narrowly defined exception. It authorises the joint payment for brokerage and research that pertains to small and mid-cap issuers and research on fixed income. Small and mid-cap companies would be defined as companies that have a market capitalisation of up to EUR 1 billion, calculated over a 12 month observation period. In the case of joint payments, the current requirement to set up a research payment account (RPA) or to issue separate invoices for research would not apply. As a counter-balancing measure, the investment firm would have to enter into an agreement with the research provider and would also be required to inform its clients of the joint payment. These amendments involve targeted changes in the current Article 13 of Delegated Directive (EU) 2017/593.   How can nascent energy derivative markets be revived? We are today proposing to amend the MiFID rules affecting energy derivatives markets. This is intended to help the development of euro-denominated energy markets – important for the international role of the euro – as well as allow European companies to cover their risks, while safeguarding the integrity of commodity markets, especially for agricultural products. The coronavirus crisis has caused an energy demand-shock followed by unusual changes in prices and volumes. In order to revive the euro-denominated nascent energy markets, we have addressed the inflexibility in the position limit regime. Position limits indicate the number of contracts a trader is allowed to enter into in a specific commodity derivative contract. MiFID II introduced these limits to avoid speculation. This is especially important for agriculture derivatives. However, for energy derivatives, the rigid approach in MiFID limits the possibility for European non-financial entities to use derivatives to hedge their real risks related to energy prices and volumes. The Commission therefore proposes that only agricultural commodity derivatives, in particular those with food for human consumption, and critical or significant commodity derivatives – having an open interest of at least 300 000 lots – will be subject to position limits. This would give more room for nascent energy derivative markets to develop without quickly reaching the position limit. Securitisation Framework More information about securitisation is available by clicking on the subtitle above. A memo is also available. What is the EU securitisation framework and what are its objectives? Securitisation is the process where a financial instrument is created, typically by a lender such as a bank, by pooling assets (for example car-loans or SME-loans) for investors to purchase. This facilitates access to a greater range of investors, thereby increasing liquidity and freeing up banks’ capital for new lending. The EU’s new securitisation regime has been in place since January 2019 and is a cornerstone of the EU’s efforts to establish a Capital Markets Union. It establishes a general EU framework for securitisation, creating a specific set of rules for Simple, Transparent and Standardised (STS) securitisation. The objective of the framework is to promote a safe, deep, liquid and robust market for securitisation, which is able to attract a broad and stable investor base to help allocate finance to where it is most needed in the economy. What do today’s targeted amendments consist of? Building on recent work by the EBA^[1], today’s proposals would complement the current securitisation framework in two targeted areas. The aim of the proposals is to encourage a broader use of securitisation in the recovery phase, by freeing up bank capital and supporting banks in their effort to enhance lending to households and businesses. The amendments would:

1. i) extend the STS framework to on-balance-sheet synthetic securitisation; and,
2. ii) remove regulatory obstacles to the securitisation of non-performing exposures (NPEs).

What are on-balance-sheet synthetic securitisations? On-balance-sheet synthetic securitisation is a type of securitisation where the originator continues to own the underlying exposures (while normally in traditional securitisation the underlying exposures are sold to another entity). They are an important risk management tool for bank lending to corporates, in particular SMEs. They are distinct from other synthetic securitisations where the originator of the securitisation does not necessarily own the underlying exposures and, instead of hedging credit risk, seeks to benefit from real or perceived arbitrage opportunities in the pricing of different tranches of credit portfolios. These are called “arbitrage” synthetic securitisations and will not qualify for the simple, transparent and standardised label. What is the main difference between traditional securitisations and synthetic securitisation? Traditional securitisation or true-sale securitisation are terms used to refer to a transaction that enables a lender – often a bank – to refinance a set of loans/assets (e.g. mortgages, auto leases, consumer loans, credit cards) by selling these assets to a Securitisation Special Purpose Entity (SSPE) and therefore converting them into securities.  Investors can invest in such securities and are repaid by the cash flows generated by the underlying loans. In synthetic securitisations, the credit risk associated with a pool of underlying exposures is transferred to investors by way of financial guarantees or credit derivatives, while the exposures themselves are not transferred to a Securitisation Special Purpose Entity (SSPE), but remain on-balance-sheet. How will today’s package help the recovery and contribute to enhancing economic growth and job creation? It will be key for Europe’s banks to continue lending over the coming months. Therefore, it is important to prepare and upgrade any tools allowing banks to maintain and even enhance their capacity to lend to the real economy, in particular to SMEs. Securitisation can be a key enabler in this respect. By moving risk off banks’ balance sheets, securitisation could free up bank capital for further lending and allow a broader range of investors to fund the economic recovery. By also extending the STS label to on-balance-sheet synthetic securitisations and related capital treatment, banks would get further incentives to use this type of securitisation, thereby releasing additional capital to lend to enterprises and households. Investors would also benefit from more simplicity, standardisation and transparency when investing in this kind of securitisation. Would this new framework entail more risks for investors? Today’s targeted amendments only extend the sound and robust EU framework for Simple, Transparent and Standardised (STS) Securitisation to on-balance-sheet synthetic securitisation. The proposed additional STS criteria are specifically designed to exclude arbitrage synthetic securitisations, which played an infamous role in exacerbating the global financial crisis. Today’s proposal will leave no door open for reviving such transactions. The STS framework was designed to increase investor protection in the securitisation market. The amendments will not undercut the high standards of the current securitisation framework for investor protection in any way. Today’s proposal neither changes the issuers’ extensive disclosure requirements nor does it weaken the far-reaching restrictions that, as a general rule, ban the selling of securitisation to retail clients. Moreover, extending the STS framework to on-balance-sheet securitisation enhances transparency and reduces the complexity of the securitisation market as a whole, as this will result in the industry using simpler, more standardised and transparent structures than today. Therefore, today’s proposal will contribute to a more stable financial system. What are the shortcomings of the EU securitisation framework with regard to the treatment of securitisations of non-performing exposures (NPEs) and why do they need to be addressed now? The current framework was not designed for NPE securitisations and is therefore not entirely fit for purpose for that type of securitisation. In particular, it contains disincentives that might keep banks from using this instrument to free themselves from the burden that NPEs entail. In its opinion submitted to the Commission in October 2019, the EBA has highlighted this problem. Amending the securitisation framework to cater for the specificities of NPE securitisations, while maintaining high prudential standards, will enable the broader use of this tool by banks to free their balance sheets from NPEs. Why is the Commission acting now when a review is already foreseen by January 2022? The securitisation framework will be subject to a comprehensive review by January 2022. Nevertheless, the Commission has adopted targeted amendments now due to their expected benefits for economic recovery and given the recent technical work carried out by the EBA. Waiting for the 2022 review to put forward these proposals would mean missing the opportunity to use the full potential of securitisation to help Europe recover from the coronavirus crisis. The current economic downturn in all Member States caused by the coronavirus crisis is expected to result in a considerable amount of bank loans becoming non-performing, as borrowers struggle to keep up with their payments. With a high level of delinquent assets on their balance sheets and the resulting increased capital requirements and operational challenges, banks would be effectively hampered from lending in sufficient quantities to underpin the economic recovery. This would happen at a time where banks are called on to keep lending to the economy as much as possible, within the current prudential framework. Today’s proposal does not substitute or diminish in any way the scope of the 2022 review, which is meant to take a broader look at the effects of the new regime, including issues such as the risk retention modalities, the use of private securitisations, the impact of the disclosure regime. The upcoming review will also be the place to take into account the recommendations of the High-Level Forum of the Capital Markets Union^[2] on scaling up the EU securitisation market. Does the proposal provide for sanctions in case of wrongdoing? The amendment will extend the current sanctioning regime that is already present in the EU’s Securitisation framework. In this respect, sanctions are provided for in case of wrongdoing by any party involved in the securitisation process. This is essential for the functioning and the credibility of the system. In particular, if a competent authority ascertains that a securitisation previously considered STS does not fulfil all STS requirements, the product will be removed from the website listing STS products and a financial sanction will be imposed on the originator (minimum €5 million, or up to 10% of the annual turnover of the legal person or other similarly large sums). The originator may also be banned temporarily from issuing STS products. Member States also have the possibility to introduce criminal charges but they are not obliged to do so. Amendment to EU rules on financial benchmarks Why are you amending the Benchmarks Regulation today? Today’s proposal to amend the EU Benchmarks Regulation (BMR) stems from the fact that one of the most critical benchmarks for the financial world – the London Interbank Offered Rate (LIBOR) – is expected to be phased-out by the end of 2021. While the BMR was designed to ensure the accuracy and integrity of benchmarks, it does not envisage a mechanism for their cessation. As there will be many contracts and financial instruments (bonds, loans, derivatives) referencing LIBOR still in place at the date of its cessation, the proposal aims to create a new framework to have a statutory replacement rate in place by the time LIBOR is no longer in use. A statutory replacement rate is a rate that the Commission can designate by law.  Such a rate would take the place of LIBOR in all contracts and financial instruments that mature after 2021.  The aim is to avoid that the cessation of LIBOR will lead to a legal vacuum, which can be exploited by those who do not wish to honour their contractual obligations.  Due to the wide use of LIBOR in the financial sector, the absence of a replacement rate could have an impact on financial stability in the EU. When and under what circumstances will the Commission be using its new powers and how will it select the replacement rate for the phasing out of LIBOR? The European Commission can designate a statutory replacement benchmark once it becomes clear that the cessation of LIBOR would result in significant disruption in the functioning of financial markets in the EU. The powers would be triggered as soon as the effective date for the cessation becomes clear. In doing so, the European Commission will take into account the recommendations made by dedicated working groups on replacement rates. For example, when designating the statutory replacement rate for USD LIBOR, the European Commission will closely align with the recommendations for all USD LIBOR tenors that will be issued by the Alternative Reference Rate Committee (ARRC) in the United States. Which contracts will not be covered by the new replacement powers and how will the replacement of such contracts be ensured? The powers of the European Commission to designate a statutory successor for LIBOR would only apply to contracts concluded by supervised entities, such as banks, investment firms or asset managers, as only these contracts are governed by the Benchmark Regulation. Contracts that do not involve supervised entities would not benefit from the statutory replacement rate.  For such non-supervised entities, the laws of the Member States would need to extend the scope of the harmonised statutory replacement rate to also cover non-supervised entities. At the appropriate time, the European Commission might recommend that national laws supplement the harmonised replacement rate that applies to supervised entities.  The European Commission is also considering setting up a working group with Member States to ensure the smooth transition of all LIBOR referencing contracts to the statutory replacement rate in a uniform way. [1] https://eba.europa.eu/eba-proposes-framework-sts-synthetic-securitisation https://eba.europa.eu/eba-publishes-opinion-regulatory-treatment-non-performing-exposure-securitisations [2] https://ec.europa.eu/info/files/200610-cmu-high-level-forum-final-report_en