Investors need more trustworthy sustainability data. Regulators should leave space for better products to emerge, while remaining alert to well-known patterns of misconduct in capital markets.
Capital reallocation towards sustainable investments is viewed as essential to Europe’s low-carbon transition. The European Union has already developed global standards with its taxonomy of sustainable activities and disclosure rules applying to financial market firms. But data on the environmental, social and governance (ESG) characteristics of companies, which are used extensively in asset management, remain a source of much frustration, and are increasingly in the regulators’ spotlight.
ESG quality means many things to many investors
ESG-focused investment has been a key trend in capital markets

The proposed EU green bond standard will be less prone to ‘greenwashing’, and the widest possible set of issuers and jurisdictions should be encouraged to use the standard.
The European Commission’s proposal for a European Union green bond standard, published 6 July, comes at a time when issuance of green bonds is booming, with the bulk being issued and traded within the EU. Demand for such assets by investors is similarly strong, though increasingly there are concerns about ‘greenwashing’ – exaggerated claims by issuers about the environmental quality of the underlying projects financed by the bonds. Dubious practices by some issuers could undermine the entire market. The EU green bond standard may not become effective for some time but nevertheless the Commission’s proposal could do

Post-Brexit UK bank regulation is not likely to compromise on international standards, but will place greater emphasis on competition, making close UK-EU dialogue essential.
Brexit has already done considerable damage to the United Kingdom’s financial sector. The EU-UK Trade and Cooperation Agreement did not secure continued market access for UK-based banks to the European Union’s financial sector, as access will depend on future regulatory equivalence decisions. In the wake of the loss of passporting rights for most banking services, about £900 billion in bank assets (or 11% of total UK assets at end-2020) has already moved to the EU. Further shifts of assets, staff and legal entities are likely as European supervisors demand that fully functional units be established within the EU.

The original paper is available on the European Parliament’s webpage, as part of in depth analysis requested by the ECON committee. Copyright remains with the European Parliament at all times.

The UK enters the post-Brexit period with a regulatory framework that is closely aligned with that of the UK, and stronger in some areas. This paper highlights that the changes in regulatory strategy and the institutional framework that have been announced by the UK will make its bank regulation more responsive, and greater use of proportionality the sector will become more competitive. Competition for EU banks in international markets will intensify, though not due to an erosion of regulatory standards.
This analysis was produced for the European Parliament’s Committee on Economic and Monetary

A net-zero emissions target is a powerful incentive for the low-carbon transition, but for bank supervisors, climate-related risks, not climate outcomes, should remain the focus.
Europe’s climate law, agreed in April, will have knock-on effects through a wide range of sector-specific legislation, with the intention of delivering on European Union states’ collective commitment to emission reduction targets and a net-zero economy in 2050. Globally, 32 countries have such targets in law or announced policy, and there has been a rapid proliferation of net-zero commitments among municipalities and large private companies. The 26 May court ruling in the Netherlands against a major European oil company suggests that failure to adhere to an ambitious decarbonisation path could be a legal as well

As European economies emerge from lockdowns, it is becoming clearer that corporate debt has reached critical levels. A new French scheme, in which the state guarantees portfolios of subordinated debt, shows how financial support could be targeted better.
Publicly guaranteed credit and moratoria have been the main instruments used by governments to support companies during the pandemic. By the end of 2020, €318 billion in loans was subject to moratoria according to the European Banking Authority, with the bulk of suspensions then expiring in the first quarter of this year. There has also been substantial use of public credit guarantees, with Italy and Spain among the most active users of this instrument. Additional credit of 8% and 9% of GDP respectively was created in these two countries

Corporate bankruptcies are set to rise in the context of COVID-19. EU countries should speed up adoption of recent insolvency reforms and, in addition, offer consistent treatment to restructuring finance.
One of the less-remarked consequences of the COVID-19 crisis, the associated lockdowns and the unprecedented collapse in demand experienced by some companies, has been a dramatic fall in business defaults and insolvencies. In a normal year, just under 200,000 insolvency proceedings are initiated in Europe, based on private sector figures (there are inherent problems in comparing national notifications). But with the onset of the COVID-19 recession, EU countries suspended regular insolvency law enforcement (an end-2020 European Commission survey showed the extent of this). Meanwhile,

Study of regulatory measures and supervisory practices that have supported public guarantee schemes and moratoria in euro-area countries prepared for the ECON committee of the European Parliament.
By:
Alexander Lehmann
Date: March 9, 2021
Topic: European Macroeconomics & Governance

This paper was prepared for the European Parliament’s Committee on Economic and Monetary Affairs (ECON). This in-depth analysis is available on the European Parliament’s online database, ‘ThinkTank‘. Copyright remains with the European Parliament at all times. 

This paper examines regulatory measures and supervisory practices that have supported public guarantee schemes and moratoria in euro-area countries. The focus is on flexibility shown with regard to default classifications, accounting

The plan to fund the European Union’s recovery programme via debt issuance has raised hopes that a new type of euro-denominated safe asset could emerge. As a priority, the European Commission needs a strategy to create a liquid and transparent market in EU bonds. For now, funding through EU green bonds would complicate that effort.
By:
Alexander Lehmann
Date: September 28, 2020
Topic: Finance & Financial Regulation

To fund its future programmes, SURE (employment support, €100 billion) and Next Generation EU (economic recovery, €750 billion), the European Union will expand considerably its role as an issuer in the sovereign debt markets. Political agreement on these programmes earlier this year has raised hopes that at long last a common euro-denominated safe asset – backed by

The European Union’s capital market union needs a revamp because of Brexit and the deep recession, and to underpin the European Green Deal. In particular, equity capital in the countries of central and eastern Europe is underdeveloped. These countries should take measures to facilitate equity finance, accompanied by reform at EU level.
By:
Alexander Lehmann
Date: September 17, 2020
Topic: Finance & Financial Regulation

The European Union’s capital markets union (CMU) plan is in urgent need of a revamp. Because of Brexit, EU capital markets and supervision need to become more integrated. The ongoing deep recession increases the need for equity finance mobilised by capital markets.
The eleven EU countries in central and south-eastern Europe which joined the EU in 2004 and after

Companies are struggling in the coronavirus crisis but solvency support provided by the European Union looks likely to be modest. This will make private equity more important in the recovery, and could create a springboard for longer-term reform to boost private equity.
By:
Alexander Lehmann
Date: September 17, 2020
Topic: Finance & Financial Regulation

The ongoing deep recession is certain to leave in its wake a significant number of corporate insolvencies, once current moratoria on debt service end. The shortfall in corporate capital could be €720 billion, based on the European Commission’s May 2020 baseline economic scenario.
The Commission put forward proposals for broad-based EU support for corporate equity but, in an effort to reduce the overall size of the bloc’s

The ongoing recession will result in a fresh surge in non-performing loans (NPLs) once payment holidays and moratoria end later this year. NPL investors played a valuable role in tackling the stock of problem loans from the last crisis, but in the aftermath of the current recession more complex financial restructuring will be needed. Governments should facilitate the refinancing of distressed but viable companies, possibly through a special regime for SMEs.
In November 2019, the European Banking Authority (EBA) and the Eurogroup reviewed progress in ‘risk reduction’ in the euro-area banking system and highlighted the improvement in the management of non-performing loans (NPL). The NPL ratio in ECB-supervised banks had fallen to 3.1% of total loans at end-2019, from 7% in 2015, mirroring

Several European central banks have begun assessing the impact of adverse climate scenarios on banks’ capital. Comparable work at EU or euro area level has evolved more slowly. Supervisors need build up a distinct and more complex type of analysis, and should engage with banks now.The release of a proposed methodology for assessing climate risks within UK banks and insurers by the Bank of England just before Christmas has fuelled calls for a similar ‘climate stress test’ for European banks.That climate risks should be a significant concern for financial supervisors is no longer in doubt. The central bank Network for Greening the Financial system (‘NGFS’, consisting of now 54 institutions) last year already called for climate-related risks to be integrated into standard financial stability

If EU banks are to mobilise a greater share of loans for sustainable projects they will need a reliable policy framework, clear internal performance targets and the relevant skills. A discount on bank capital underlying such assets is neither justified nor likely effective. A comprehensive review of how climate risks are reflected in prudential regulation is nevertheless in orderThe Commission’s ‘European Green Deal’ sets out massive investment needs in a variety of areas, amounting to potentially 1.5 per cent of the EU’s annual GDP. If these targets are to be met it is clear that in addition to the various EU and European Investment Bank (EIB) instruments, European capital markets, banks and other financial institutions will need to significantly reallocate funding. A review of how

This paper gives an overview of the seven aspects of resolvability defined in 2019 by the Single Resolution Board, and then assesses progress in two key areas, based on evidence gathered from public disclosures made by the 20 largest euro-area banks. The largest banks have made good progress in raising bail-in capital. Changes to banks’ legal and operational structures that will facilitate resolution will take more time. Greater transparency would make it easier to achieve the policy objective of making banks resolvable.In the five years since the adoption of the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism Regulation (SRMR), preparations for the orderly failure and resolution of systemically important banks in Europe have made significant progress.

The EU model of financial market regulation is increasingly copied by third countries. In this context, the EU’s efforts to promote its model beyond its borders should take into account the underdevelopment of financial markets in many partner countries, and the often insufficient capacity of regulators and supervisors. By: Alexander Lehmann Date: November 20, 2019 Topic: European Macroeconomics & Governance The EU’s policy in its neighbourhood in eastern Europe has for some time been to encourage countries to bring their regulatory standards into line with those of the single market, in exchange for increased access to EU markets.In financial services, this policy is motivated by the need to prevent financial instability being imported from third countries into the single

Euro-area bank integration has decreased as post-financial crisis national rules require banks to hold more capital at home. It might be undermined further by bank resolution planning. Either a Single Resolution Board takes the lead for the entire banking group or independent local intervention schemes need to be developed for crisis resolution. By: Alexander Lehmann Date: November 19, 2019 Topic: European Macroeconomics & Governance The deep involvement of a number of euro-area banking groups in central and southeastern Europe has benefitted the host countries and has strengthened the resilience of those banking groups. But this integration has become less close because of post-financial crisis national rules that require banks to hold more capital at home, or other ring-fencing

The incoming Commission President has put support for SMEs at the centre of her economic programme. A public-private fund investing in initial public offerings should be carefully targeted, primarily at small firms with risky projects. The announced SME strategy and further measures under the Capital Markets Union programme should address numerous other barriers to both public and private equity finance. By: Alexander Lehmann Date: September 16, 2019 Topic: Finance & Financial Regulation Over the first five years of the EU’s capital markets union (CMU) agenda the financing mix of European small and medium-sized enterprises (SMEs) has barely changed, and remains heavily biased towards internal funds, and bank loans. Figures from the latest EIB investment survey show that for

Croatia seems a suitable candidate for euro area accession: there is a tight peg to the euro, high public debt is coming down, and the banking sector is already dominated by euro area banks. But the Eurogroup has rightly targeted reforms of the state’s role in the economy as a precondition for participation in ERM II and the banking union. None of the announced reform plans are new or easily concluded within the timeframe that has now been agreed.
By:
Alexander Lehmann
Date: July 18, 2019
Topic: European Macroeconomics & Governance

Last week, the Eurogroup set out the criteria for Croatia to enter the ERM II (the European Exchange Rate Mechanism), designating the country the second candidate to accede to the common currency.

The discussions of the now-aborted merger of Germany’s two largest banks underlined supervisors’ concerns over creating banks that are too big or too complex to fail. While European banks are increasingly funded through securities that could be subject to a bail-in, transparency over how any resolutions would unfold is as yet very poor.

Three factors seem essential in ensuring the success of Europe’s framework for bank resolution: sufficient loss-absorbing capacity; adoption of organisational structures that allow critical functions of banks in resolution to be preserved while other parts are wound down in resolution; and cooperation with resolution authorities outside the banking union that reflect the extensive ownership linkages of European banks.
While banks have made some

Europe’s largest banks have made progress in issuing bail-inable securities that shelter taxpayers from bank failures. But the now-finalised revision of the bank resolution directive and a new policy of the SRB will make requirements to issue such securities more onerous for other banks. In order to strengthen banking-system resilience, EU capital-market regulation should facilitate exposures of long-term institutional investors.

The ECB’s March policy meeting announced not just a delay in the expected interest-rate hikes, but also a new round of bank refinancing operations (the so-called LTRO-III). Additional bank funding was justified by substantial amounts of bank bonds falling due just as the previous round of refinancing operations comes to an end. In addition, as of last year,

With the end of the Greece support programme, authorities now have scope to focus on the legacy of NPLs and excess private-sector debt. Two wide-ranging schemes are under discussion. They should be assessed in terms of required state support, likely investor appetite for problematic bank assets, and institutional capacity to manage a complex new organisation tasked with debt restructuring.
By:
Alexander Lehmann
Date: January 29, 2019
Topic: European Macroeconomics & Governance

Greek NPLs: reforms under the ESM programme are yet to make a big dent  
With €90 billion in non-performing loans (NPLs) as of late 2018, equivalent to 43% of all loans, Greece remains a crucial testing ground for the strategy on ‘risk reduction’ in

Bank failures have multiple causes though they are typically precipitated by a rapidly unfolding funding crisis. The European Union’s new prudential liquidity requirements offer some safeguards against risky funding models, but will not prevent such scenarios. The speed of events seen in the 2017 resolution of a Spanish bank offers a number of lessons for the further strengthening of the resolution framework within the euro area, in particular in terms of inter-agency coordination, the use of payments moratoria and funding of the resolution process.

This material was originally published in a paper provided at the request of the Committee on Economic and Monetary Affairs of the European Parliament and commissioned by the Directorate-General for Internal Policies of the Union

Poland’s issue of a green bond earlier this month was the country’s second financing of this type, and the first ever repeat issue by a sovereign. It has revived the debate as to whether there should be a single regulatory standard to certify the environmental quality of financial assets. This will be a key issue for the EU’s sustainable finance strategy which is due to be released shortly.
By:
Alexander Lehmann
Date: February 19, 2018
Topic: Finance & Financial Regulation

Global climate targets, and in particular the Paris Agreement of 2015, have fuelled investor demand for ‘sustainable’ financial assets. This is now reinforced by the scrutiny that supervisors apply to the carbon exposures of the financial industry, and the

The resolution of non-performing loans (NPLs), a stock of roughly €870 billion in the EU banking industry, is central to the recovery of Europe’s banking sector and the restructuring of the excess debt owed by private sector borrowers. Could the development of distressed debt markets be a new element of capital market deepening in Europe?
By:
Alexander Lehmann
Date: January 18, 2018
Topic: Finance & Financial Regulation

The market for distressed debt will need to play a more prominent role in Europe’s emerging strategy to tackle the legacy of non-performing loans (NPLs). This market could speed up NPL resolution and allow greater flexibility in bank balance sheet management. Investors could contribute crucial skills

The introduction in 2018 of forward-looking provisioning for credit losses in EU banks delivers on a key objective in the post-crisis regulatory agenda. This was intended to dampen future lending cycles. For now, banks will be sheltered from the impact on regulatory capital requirements, as the implications for financial stability are far from clear. In any case, the new standards should encourage the disposal of banks’ distressed assets, underpinning the ongoing agenda on NPLs.
By:
Alexander Lehmann
Date: November 13, 2017
Topic: Finance & Financial Regulation

As one of the final items in the post-crisis regulatory agenda, IFRS9 will come into effect for financial institutions across the EU in 2018. The new accounting

Separating ‘legacy assets’ from banks’ core business is central to the rehabilitation of Europe’s banking system. How can Europe progress in its ongoing effort to rid the financial system of legacy assets, and equip it with renewed growth?

This paper was originally produced as a testimony for the European Parliament.

The separation of so-called legacy assets from the remaining healthy business of a bank has become a central concern in risk management and supervision. In the European Union, non-performing loans amount to over €1 trillion and an additional stock of non-core assets that is at least as large is also being offered in the secondary market.
Banks have employed various organisational models to separate these assets from their core business. At one extreme, banks have tasked specialist staff to focus on workout or selective sales, while the bulk of these assets remain on the same balance sheets. To do this, appropriate incentives have to be set for bank staff, and a number of failures that are inherent to the market for loan sales have to be addressed.
At the other extreme, in situations of serious distress, countries set up external asset management companies (AMCs), either specific to an individual bank, or working across the industry for specific types of loans.

Insolvency regimes in the euro area are on the whole costly, lengthy, and recover little value. A new directive proposed by the Commission sensibly aims to strengthen preventive restructuring and to give once-failed entrepreneurs a second chance. But to assist banks in their NPL workout judicial capacity will need to be built up, and regimes better tailored to SMEs will be necessary.

The ECB’s new guidelines on the management of non-performing loans (NPLs) will shine a spotlight on the way banks deal with NPLs. Both supervisors and market analysts will be scrutinising banks’ efforts to work out loan delinquency in enterprises and households. The need to address financial distress early will be further reinforced in 2018 when the EU’s new accounting standard (the IFRS 9) will force banks to recognise loan impairments on the basis of expected, rather than actual, credit losses.
Banks’ workout efforts, their attempts to restructure, divest or write off their portfolios of NPLs, will be shaped by the quality of national regimes for insolvency and restructuring. As is well known from the World Bank’s Doing Business indicators, insolvency procedures in several euro area countries are costly, lengthy and result in inadequate value recovery. There have been a number of notable reforms but on the whole regimes are still biased towards liquidation, rather than restructuring.

Distressed asset investors can relieve banks of their NPL overhang and offer valuable restructuring expertise, although banks will need to realise a further valuation loss. Regulators could do a lot to support the growth of this market.

Over the coming months the European financial sector will need to digest a whole spate of bank restructurings. The sale of distressed loans will be a key element in recovery plans, such as we see in the recently-approved sale of a portfolio of EUR 27 billion book value by Italian bank Monte dei Paschi.
But relying on the secondary market only will be a sensible strategy if that market is liquid. Third parties need to be able to apply workout methods in debt resolution that recover value more efficiently than banks’ in-house processes.
As the latest ECB Financial Stability Review makes clear, Europe has not succeeded in building a vibrant market for distressed debt. Private sector advisory firms estimate the stock of non-performing loans and other ‘non-core’ assets at about EUR 2 trillion, of which only about EUR 100 billion transact per year.
Some euro area countries with systemic NPL crises, such as Greece, have seen no transactions at all in recent years. In the US this market is both more liquid (with an annual investment about seven times that in the EU in 2013), and also assigns investors a more prominent role in workout efforts.

Growth in Spain again exceeded expectations this year, and bank deleveraging appears to have reached an end. Addressing non-performing loans was a precondition for recovery, and it required comprehensive financial sector reform.

Recent figures for bank lending in Spain suggest that more than seven years of deleveraging from domestic lending to households and enterprises are about to come to an end (see chart). Volumes of new lending to households and SMEs have registered growth since early 2014. This represents an important turnaround for a banking sector that threatened sovereign market access only four years ago.
The health of the sector has improved considerably since then. The NPL ratio has now fallen to 9.4 per cent of total loans, as the concentration in real estate assets was much reduced. In 2015 alone this represented a fall by over one fifth in the stock of distressed assets.
Following the sharp provisions in 2012 the sector has been modestly profitable, currently with a 6.8 per cent return on equity (RoE) according to data from the European Banking Authority. This made it possible to rebuild capital ratios. Moreover, despite years of deleveraging at home, key banks continued to expand a profitable foreign business – in Europe and, until recently, in Latin America.