Capital markets, financial stability and supervisory convergence: an alliance for recovery
CIRSF Annual International Conference 2020
Lisbon, 12 November 2020
‘Major Trends of Financial Regulation: The EU Governance of Financial Supervision and What to Expect from Banking Union and a Renewed Capital Markets Union in a Context of Crisis and Safeguard of Financial Stability’
Gabriela Figueiredo Dias
Good morning. I would like to start by thanking Professor Luís Morais for this initiative and for bringing together such a distinguished group of speakers and panellists, despite the current difficult circumstances. In times where we are being strongly requested to join efforts and to tread the recovery path alongside, the CIRSF project, bringing financial regulators to reflect together about the financial system, is more important than ever.
These are indeed difficult times. In recent weeks, the surge of coronavirus infections has led to a worrisome situation and the turning point of the fight against the pandemic is not yet visible. As a consequence of the sanitary crisis, the social and economic impacts are striking and long lasting, even if the very recent news on a possible vaccine is shedding some faith on the future.
In the first half of the year, the pandemic outbreak and associated lockdown measures took a severe and unprecedented toll on the EU economy. The rebound, which began in May, is now facing new difficulties with the re-introduction of severe restrictions.
The impacts were different across member states, but Portugal is certainly an economy that has been heavily impacted. The forecast for Portugal is worse than that for the euro area in 2020, and the uncertainty about when will the numbers of coronavirus infections in Portugal start to decrease renders these forecasts even more uncertain.
After the March turmoil in global markets, summer brought some good news. Inflows to the funds industry increased and equity markets recovered partially – and in some jurisdictions even more than recovered from the pre-summer lows -; credit spreads adjusted to median levels, and debt costs fell to pre-crisis levels, with significant bond issuances across sectors.
Since September and more crucially in October, the market mood changed somewhat. The new pandemic wave triggered a strong increase in volatility (back to June levels), we have observed significant declines in stock markets in several jurisdictions and a slight increase in the outflows of funds at European level, including Money Market Funds.
The developments of the last weeks are a stark reminder that even with the massive monetary and fiscal stimulus that prevented a global depression, we are still facing a rather high economic and financial uncertainty. The heavy toll the pandemic will still have on our social fabric, as well as on health and social security systems is a good example of that uncertainty. And so is the decoupling of market prices from the real economy, that is still to be fully explained and might result in significant adjustments going forward.
In this context, credit risk is expected to increase, reflected in corporate bonds downgrades and business bankruptcies, as more restrictions are being imposed in response to the second wave of the pandemic. It is also foreseeable that the level of non-performing loans held by EU banks will increase in the coming months, further affecting bank’s profitability and ability to continue funding the real economy as needed.
Given the level of the challenges ahead, strong and smart policies are needed to enhance the contribution of the financial system to the recovery, in particular to take advantage of market instruments to diversify risk and financing options for companies and offer better saving alternatives to families.
Capital markets may and should have a significant contribution to the recovery, also because banks will not be able to provide all the funding needed to overcome the pandemic and set in motion a growth strategy. In particular, capital markets can offer funding for activities and entities that would traditionally not be served by the banking sector, like innovative businesses and SMEs. They can attract institutional as well as retail investors and transform their money into funding opportunities. And by doing so, contribute significantly to innovation and the competitiveness of the European economy and the wealth and welfare of its citizens.
But, can we truly be optimistic as to seeing a valid contribution from the capital markets to the long-term economic recovery? Can we expect the markets to steer that recovery in a new direction, where digital, environmental and social dimensions are effectively considered and supported by proper governance?
Not surprisingly, my answer is – yes, we can. But it takes some conditions and comes at a price. We need to provide simple and attractive products to families and companies, offered by well governed entities and respectful, to say the least, of environmental, social and governance concerns; to reduce the risk of financial and supervision fragmentation; and to earn the trust of our fellow citizens.
The Capital Markets Union action plan, alongside other initiatives, such as the EU Sustainable Finance and the FinTech Action Plans, are timely and important steps in the right direction. But their success will much depend on the attractiveness of the market alternatives offered to the families and the community, as well as on the trust in capital markets that we are able to build.
For that purpose, European capital markets are and need to be very much focused in offering products that are properly designed, comparable and transparent in terms of costs, risks, and returns and offer returns adjusted to investors’ profiles and expectations. Products that are sold and advised bias-free, by competent and compliant professionals. Product governance, fees and costs transparency and mitigation of conflicts of interest at all levels are key elements of attractive and reliable capital markets.
On the sell side, European companies need to risk investing in innovation and long-term structural projects, to attract talent and to foster competitiveness. But we also need innovative vehicles or structures, different from banks and prone to capture and aggregate great amounts of funds and channelling them to SMEs, ensuring that available liquidity and projects in need of funding meet each other.
Finally, the underlying element in the successful provision of innovative and adjusted services and products must be professionalism, based not only on technical but also ethical rules, allowing for the proper consideration of the clients’ interest and of all the involved stakeholders.
In a nutshell, we need sound business models and fit & proper top executives, that stand on strong values and ethical principles, solid professionalism and appropriate board and governance culture. This is the only way to generate trust and recover confidence.
Regulation and supervision are decisive instruments in the development of competitive and efficient capital markets that European citizens can trust. And although much remains to be done, the good news in that much has been done in the last years, and that we actually have the tools to act. Rather than developing new rules, the challenge is more one of strengthening supervisory convergence – and maybe even, in very limited cases, of centralized coordination when financial stability is at stake.
While investors’ trust in capital markets depends on a critical cultural change in companies and on fierce adherence to the highest ethical and quality standards, it is important to note that current regulation already allow regulators to assess and act on boards’ culture, effectiveness and integrity. These rules may and should be strictly enforced. And the European Central Bank deserves high regards for the work done in this respect since the last crisis.
On another front, offering adequate products, providing alternative funding solutions to companies and contributing to financial stability in the European Union surely takes well supervised capital markets, with a proper single rule book and enhanced supervisory convergence. Supervisory convergence is not only essential to ensure a level playing field, but also to ensure confidence and strategic alignment between markets and jurisdictions and a true union of the European capital markets, making Europe consistent, robust and reliable to households and to companies amidst the markets’ ebbs and flows.
In this regard, ESMA has been playing an undeniably valuable role which has been recently enhanced by the new tools, powers and responsibilities arising from the European Supervisory Authorities Regulation Review.
The definition of Union strategic supervisory priorities that national supervisors shall take into account in their annual planning; the EU supervisory handbook that ESMA is starting to develop; the Heathmap, whereby the main European supervisory risks and priorities are annually identified; or the Common Supervisory Actions, by which all national supervisors are already launching simultaneous supervisory actions with the same scope, criteria and methodologies, are relevant and innovative tools towards alignment and consistency, building on the contributions from all member states.
In parallel, ESMA has gained new direct supervision powers on systemically relevant third country Central Clearing Counterparties (CCPs), EU critical benchmarks and their administrators and data service providers, alongside with the already existing direct supervisory powers on Credit Rating Agencies and Trading Repositories. This is however just a small fraction of the entire universe of entities and activities under supervision. Central direct supervision or a Banking Union-alike model is not (or at least, not yet) the foreseen evolution of the roadmap for capital markets supervision.
However, I do believe we need to continuously assess the resilience of the existing European market supervision model, based on national supervision authorities, to the changing nature of the risks, in particular when the EU financial stability is at stake.
We need to keep proximity as a means for better understanding the market and its particularities, national specificities and cultures. But we also must tackle inconsistencies that are detrimental to integrated markets and financial stability. To this end, the new CMU plan rightfully requires the Commission to consider proposing measures for stronger supervisory coordination or direct supervision by the European Supervisory Authorities.
One way or the other, it is certain that where the option for national supervision is kept, fully harmonised interpretations of rules and coordinated and convergent supervision are fundamental conditions of the market.
In addition, a growing focus of markets regulators on prudential and macroprudential supervision is absolutely key and already being embedded in our mandates and strategies. This is also contributing to dilute the classical, unnecessary and detrimental tension between prudential and market conduct supervision, and between micro and macro responses, paving the way for an integrated and holistic capital markets supervision model, irrespective of its institutional structure.
One important thing that I would like to leave very clear in this forum is that financial stability is becoming a central part of market regulators’ agenda. Consequently, new specific approaches and perspectives are needed to properly regulate and supervise capital markets under such a perspective.
In fact, capital markets will only be a real complement to traditional banking financing by equipping the financial system with a larger capacity to absorb, while not creating, new relevant systemic impacts.
The sudden, impactful and quick shock that occurred in March this year was a real-life stress test for many market entities. Although in general they successfully passed the first Covid-test, much work must be done based on the evidence collected from the reaction to the shock, in order to reinforce their capacity to contribute to financial stability. This is exactly what we are already doing at the CMVM and at ESMA level, in particular at the Investment Management Standing Committee that I’m honoured to chair, also in response to the ESRB recommendation on investment funds liquidity, that should be published today.
While the jury is still out on what might be the needed adjustments, any answer should adopt a balanced approach, that assures sectoral appropriateness, calibration and proportionality of possible initiatives, while searching for effective combinations of supervisory and enforcement measures whenever possible, instead of regulatory changes.
Indeed, and notwithstanding very specific amendments that may be required to improve our regulatory framework, we should prioritize harmonised supervision and enforcement practices as a means to promoting stable and orderly markets and enhance investor protection.
Simply importing bank-like solutions that are not suitably adjusted for capital markets would be the wrong way to go. This would affect the efficiency of this sector and prevent it from being a viable funding alternative of increased relevance, namely in crisis contexts, which ultimately would affect financial stability. The way forward should be to provide and make use of a market specific, tailor-made toolkit for market participants and regulators to address financial stability issues.
With that purpose, capital markets’ supervisors, being fully aware of the risks posed by and inflicted on the capital markets, are following a hands-on approach in the creation by design of an appropriate macro-prudential framework and specific tools, that will deliver proper risk prevention and mitigation
This financial stability objective – and to put it more broadly, the development of efficient capital markets in the European Union – can only be achieved through a constructive dialogue across sectors, cultures, jurisdictions and institutions. Relevant and granular information and thorough analyses must be continuously shared. We will not have integrated and stable markets in Europe unless we work in an integrated manner. This also means that ESMA, EBA, EIOPA, ESRB and ECB – and needless to say, CMVM, Banco de Portugal and ASF – must work alongside towards the common goal of promoting a strong and dynamic financial system that can foster growth across our economies and be at the service of our fellow citizens.
Cooperation is, thus, key. And this is why CIRSF initiative to bring us all together is so important. Thank you, Luis. I wish us all a good day of debates.