The start of a new five-year political cycle has just begun in the European Union, and both EU citizens and their leaders believe the current term will have a decisive impact on the future direction of the European project.
Citizens went to the polls to elect a new European Parliament in May, followed by the allocation of top positions in the other major European institutions in early July. Many commentators feared the rise of nationalism and "Eurosceptics," however more than 50% of EU citizens voted in the highest turnout rate in 20 years to largely support a pro-European agenda.
Here's what the election could mean for derivatives markets in the coming months.
A look at leadership
First, it's helpful to look at the general balance of power in the new European Parliament to get a general sense of where policies may be headed.
The centre-right European People's Party (EPP) and the centre-left Socialists and Democrats (S&D) lost a huge number of seats in the election, losing their combined majority for the first time since the inception of the European Parliament. As a result, centrist politicians will have to seek the support of partners farther to the left or farther to the right to achieve consensus. For instance, strong results for the green parties in the European Parliament elections suggest that we are likely to see a "greening" of European policies across the board, including on economic and financial issues.
The "winners" of this election were the Renew Europe group — formerly the Alliance of Liberals and Democrats for Europe (ALDE) — which become the third largest political group, and the Greens/European Free Alliance.
On 2 July, after three special meetings, the 28 EU Member State leaders reached an agreement on the nominations for the top jobs within the parliament.
Germany's Ursula von der Leyen was nominated as European Commission president for the next five-year legislative term starting on 1 Nov., taking over from Jean-Claude Juncker.
A centre-right politician most recently serving as defence minister, von der Leyen was a member of German Chancellor Angela Merkel's cabinet from 2005 until her election as Commission president.
In what can be assumed as an exchange for ceding the presidency to Germany, France's Christine Lagarde, the former head of the International Monetary Fund, was nominated as president of the European Central Bank to replace Italy's Mario Draghi. Lagarde has been dubbed a "political rock star" with no economic training and no practical experience of monetary policy, and there are indications that she will move the central bank closer to European politics and away from some of the independence with which the institution has operated in the past.
After the tensions over the EU top jobs between Merkel and Macron, a deal where von der Leyen is president of the Commission and Lagarde is ECB president reinforces a Franco-German axis of influence that was absent during the last legislative term.
It's also worth noting that a crucial aspect that shapes European policy-making is how the European Commission is structured. When he took office in 2014, Juncker created more horizontal portfolios given to six vice presidents who were all responsible for "project teams." This organisation in clusters was aimed at promoting collaborative work on common issues such as achieving a capital markets union, an energy union and a digital single market.
This organisation was very specific to Juncker and it remains to be seen whether the same approach will be endorsed by his successor von der Leyen.
If the cluster organisation is here to stay, many Brussels observers predict that a new horizontal portfolio dealing with sustainability issues will be created. Beyond environmental and climate issues, such a portfolio could supervise issues ranging from sustainable finance to transport and agriculture.
Capital markets and banking union
The president-elect has included the completion of the capital markets union as one of her key priorities. Another priority is the completion of the banking union through a common backstop to the Single Resolution Fund and the European Deposit Insurance Scheme. For her part, ECB president Lagarde has also stated a strong commitment to building a deeper integration of the Eurozone's financial sector by completing the banking and capital markets union. SMEs Von der Leyen has pledged support for small and medium sized enterprises with a goal of granting these firms major access to financing to help foster growth and innovation. In the same vein, the presidentelect has advocated for a private-public fund specialising in initial public offerings of SMEs, with an initial investment from the EU that could be matched by private investors.
Technology and the environment
In the area of technology and innovation, von der Leyen proposed to launch a New Digital Services Act in her first 100 days of office. Also, a European approach on the human and ethical implications of artificial intelligence, the development of joint new standards for 5G networks, and the taxation of big tech companies are cornerstones of her mandate. In terms of environment and climate change, she affirmed that "Europe must lead the transition to a healthy planet." To make that possible, a European Green Deal Package will be launched, including a European Climate Law which will aim to reduce CO2 emissions by 55% by 2030.
New faces at FISMA and ECON
Looking at financial services policy in the European Commission, a significant number of changes in personnel are expected in the Directorate General for Financial Stability, Financial Services and Capital Markets Union (DG FISMA), which could lead to much uncertainty.
The biggest question mark in this respect is the next FISMA commissioner. Since Commissioner Jonathan Hill's resignation in the aftermath of the Brexit referendum in 2016, no new FISMA commissioner has replaced him; FISMA responsibilities were taken over by Commission Vice President Valdis Dombrovskis, who was also in charge of the Euro and Social Dialogue. With the UK on its way out of the EU, Europe will lose its biggest financial and capital market centre and the new FISMA commissioner will have to deal with new challenges — primarily, around how to build a truly continental capital markets union after Brexit and what kind of relationship it wants to build with the UK once it becomes a third country.
On the administrative level, the two most senior positions within DG FISMA are expected to become vacant. The current director general, Olivier Guersent, is set to change positions, while Deputy Director General John Berrigan is also rumoured to be leaving FISMA soon. It is too early to know who will replace these senior figures, although they are likely to be appointed only once the new commissioner is chosen and approved by the European Parliament in October.
Turning to the new European Parliament, we observe a very high turnover of MEPs within the Economic and Monetary Affairs (ECON) committee.It is also important to note that French Liberal MEP Stéphanie Yon- Courtin was appointed as Second vicechair instead of Italian Eurosceptic MEP Antonio Maria Rinaldi. This came as a surprise and may be indicative of the way that the main Parliamentary Groups will deal with the Eurosceptic forces within the ECON Committee.
Additionally, the Groups have already selected their coordinators ("whips") for ECON. These posts can be very influential in areas important to FIA and its members.
Both Germany's Markus Ferber of the centre-right European People's Party and Spain's Jonás Fernández of the centreleft S&D return as coordinators of the two largest political groups, as well as Germany's Sven Giegold of the Green Party. All other ECON coordinators are newly-elected MEPs.
It is also worth bearing in mind that the Liberal contingent (formerly ALDE, now Renew Europe – RE) in ECON is completely new compared with the previous mandate. In particular, the French presence within RE is very strong. There is no longer a single UK Tory MEP in the ECON Committee, whereas they previously made up the majority of the European Conservatives and Reformists (ECR) contingent in the previous mandate. The Spanish presence in ECON is much stronger, both within S&D and RE (in these two groups the ECON coordinators are Spanish). The Northern European countries and Baltics, which are traditionally more pro-industry, have a small presence in ECON.
Key Issues
Sustainability
Sustainable finance has become the key focus in Europe since the unveiling of a Commission Action Plan in March 2018. It was launched and promoted by Vice President Dombrovskis, who explained that "sustainable finance is one of the missing links in the fight against climate change, and for a more sustainable economy."
The main objectives of the EU's sustainable finance work is to support economic growth while reducing pressures on the environment, addressing green-house gas emissions and tackling pollution, as well as minimising waste and improving efficiency in the use of natural resources. It also intends to address threats and risks that climate change can have on the financial system while fostering the development of existing market-led initiatives, such as lowcarbon benchmarks or green bonds.
Three pieces of key sustainability legislation have been proposed so far at the Commission:
- A disclosure regulation which sets out an harmonised EU approach to the integration of ESG risks and opportunities into the disclosure procedures of financial market participants and financial advisors;
- A low-carbon benchmarks regulation which sets out a tool to pursue low-carbon investment strategies by establishing two types of financial benchmarks.
- A common EU taxonomy defining conditions for identifying environmentally- sustainable economic activities and empowering the Commission to establish technical screening criteria and framing how these criteria would have to be defined.
In parallel to these proposals, the Commission established Technical Expert Groups on taxonomy, low-carbon benchmarks, green bond standards and disclosures to deal with the practical and technical applications of these new pieces of regulation. Future work is also likely to include eco-labelling.
Fintech
The Commission proposed a Fintech Action Plan in March 2018, building on the work of its Fintech Task Force. The Action Plan set out 19 proposals to enable innovative business models to scale up, support the uptake of new technologies across the EU, and increase the security and resilience of the financial services sector.
The Commission tried to avoid regulating prematurely or poorly, and instead focused on gathering as much information as possible from regulators and interested stakeholders ahead of the current legislative mandate. The Fintech Action Plan therefore foresaw the creation of the EU Blockchain Observatory and Forum, a stakeholder platform, to monitor blockchain developments, and an enhanced role for the European Supervisory Agencies in mapping current legislative frameworks and supervisory practices.
Going forward, we can expect the Commission to build on its preparatory work and recommendations (as well as that of international bodies), fund innovative projects through the next EU budget and consider horizontal legislative initiatives focusing on crypto-assets, cybersecurity and technology neutrality.
The role of the Euro and EU in global markets
As political forces in Europe from both from the left and the right are urging to protect the continent's interests and to protect its borders, a new work stream on the international role of the euro could be a key issue to watch at the European Commission. This is a multi-faceted topic, ranging from finance to trade and energy considerations, and seeks an increased international role for the euro as a tool to strengthen Europe's influence in the world.
Post-crisis reforms: MIFID and EMIR
One of the most substantial pieces of work coming up in this term is the review of MiFID II, the Markets in Financial Instruments Directive. A significant amount of work has already been done on the MiFID package, so this review is primarily expected to be technical and to assess what has worked well and as intended since MiFID II came into force in January 2018 — a year later than expected — and what needs to be recalibrated and re-worked.
However, this review takes place within a very specific context as the U.K., Europe's biggest capital market, will most probably have left the EU. This will raise a number of questions were not necessarily expected to be re-opened. In addition, many of the provisions of MiFID II that should be assessed next year as written into the final legislative text will no longer be tackled.
Earlier this year ESMA wrote to the Commission announcing that it would delay delivery of a number of reports considering the uncertainties introduced by Brexit and that it aims to ensure that enough experience is gathered on the application of MiFID II/MiFIR before beginning the review of the functioning of the various MiFID II provisions.
Another big area of work for the new Commission will be the calibration of Level 2 measures under European Markets Infrastructure Regulation, EMIR 2.2, which deals with supervision of EU and third-country CCPs. ESMA has already consulted on tiering of third-country CCPs, comparable compliance, and fees to be paid by the third-country CCPs.
Although much of this process is deemed technical in nature, industry engagement will be necessary to ensure that EMIR 2.2 is practical and workable. Furthermore, co-legislators in member states represented by the Council and the European Parliament will also need to give their approval to the final standards. This may cause political battles, especially in a context of tense relations with the U.S., where the European approach as regards third-country CCPs is considered too far reaching and may endanger previously agreed equivalence decisions between the EU and the U.S.
CCP recovery and resolution
In the field of cleared derivatives, there is one draft proposal which still needs to be agreed at Level 1 by the Council and Parliament: a regulation on recovery and resolution of CCPs.
Following the technical review of EMIR (EMIR Refit) and the new rules on supervision and governance of European and third-country CCPs (EMIR 2.2), the last leg of CCP-related legislation in Europe is recovery and resolution. The Commission unveiled its proposal in November 2016 and the European Parliament adopted its position in January 2018, but the Member States decided to prioritise the EMIR review instead and delayed negotiations on CCP recovery and resolution for almost two years. They have now resumed discussions on this file in the Council and an agreement may be in sight by year-end.
Early 2020 could see the start of so-called "trilogue" negotiations between the Commission, the Parliament and the Council to reconcile positions in one final text. Negotiations on this file are complicated. In the industry, there is a clear dividing line between clearinghouses and clearing members, who disagree on the tools to be used in case of recovery and resolution and who will bear the brunt of any loss whether from a default or not.
Capital requirements
With the finalisation of Basel 3 standards by the Basel Committee on Banking Supervision in December 2017, it remains to be seen how these new rules can be integrated into EU law.
There was a very broad reform of the banking legislation in Europe last year. Amendments were made to the Directive and Regulation on Capital Requirements (CRR/CRD), the Banking Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism (SRM) that implemented some of these new Basel standards into the EU legislative system such as revised rules on the leverage ratio and the new rules on the leverage ratio buffer.
However, other rules could be more contentious. These include revisions to the prudential standards for credit, operational and credit valuation adjustment (CVA) risk, replacement of the so-called "Basel I floor" with an aggregate output floor (OF) and the Fundamental Review of the Trading Book (FRTB).
In addition, the recently agreed changes by the Basel Committee on the leverage ratio for client cleared derivatives will also need to be discussed and addressed at the EU level. The BIS recommends a targeted revision to align the leverage ratio measurement of client cleared derivatives with the measurement determined per the standardised approach to measuring counterparty credit risk exposures (SA-CCR) as used for risk-based capital requirements. This treatment will permit both cash and non-cash forms of segregated initial margin and cash and non-cash variation margin received from a client to offset the replacement cost and potential future exposure for client cleared derivatives only.
Cross-border equivalence
Every piece of financial services legislation provides for equivalence mechanisms in order to determine that third-country rules, markets and/or participants in a specific area of financial services are deemed similar in effect to those of Europe. Those equivalence decisions were, until now, mostly agreed at technical level by regulators and supervisors of both jurisdictions.
However, since the Brexit vote in the UK, there is a growing trend in Europe to streamline equivalence mechanisms across the different pieces of financial regulation and to use them as a more political tool. This was clearly illustrated in the Commission Communication "Equivalence in the area of financial services", published on 29 July, which states that "equivalence decisions are unilateral and discretionary acts of the EU… As part of its discretion, the Commission may decide to formally adopt, suspend or withdraw an equivalence decision, as necessary."
In this context, it is not surprising that we also observe increased politicisation of equivalence decisions. The example of new restrictions between the European Union and Switzerland is the best illustration of this trend. In not granting an extension to the Swiss equivalence decision, the Commission underlined its commitment to take into account effective cooperation with a third-country jurisdiction across other EU policy areas. This is seen as a worrying precedent in the Brexit context. Specifically, would the EU suspend or revoke equivalence to the UK if a bilateral trade negotiation were not to progress in a way that the Commission would like?
Equivalence in financial services is therefore expected to top the political agenda of the next mandate, especially given the wider concerns around the EU and how it faces global partners. The European Parliament already adopted a non-binding report on this issue last year but the Commission's Communication could translate into concrete legislative proposals. MEPs will likely reinforce the politicisation of this issue, with heated debates expected between the different political groups.
About Freshfields Bruckhaus Deringer: Freshfields is the world’s oldest global corporate law firm with teams spanning specialisms, regions and industries. Its Brussels office is home to a dedicated EU Regulatory & Public Affairs function which advises FIA on its engagement to EU decision-makers and strategic advice on financial services policy at the EU level. Freshfields assists FIA in understanding the political driving forces behind policy initiatives impacting the cleared derivatives space and how best to educate the Brussels decision-making community to secure the right outcomes for the industry.
