European Financial Industry Developments

ECB Publishes Opinion on Proposed Regulation Amending EBA Regulation

The European Central Bank ("ECB") published an opinion (CON/2018/19) (dated April 11, 2018) on a proposed Regulation amending (among other things) the EBA Regulation (Regulation 1093/2010) on April 12, 2018.

The proposed Regulation forms part of the European Commission's legislative proposals for reforms to the European System of Financial Supervision ("ESFS"), which were published in September 2017. In November 2017, the Council of the EU requested an opinion from the ECB on the proposed Regulation.

In the opinion, the ECB welcomes the proposed Regulation's objective of fostering effective and consistent prudential supervision and regulation across the EU. It supports further integration of the supervisory framework at EU level for the banking sector and strengthening supervision by re-examining the current set-up of the European supervisory authorities ("ESAs") (that is, ESMA, EIOPA and the EBA).

The opinion sets out the ECB's general observation that the banking union and the capital markets union ("CMU") are at different stages of progress. The review of the ESAs should not necessarily produce three identical outcomes for the three ESAs, but should address their respective mandates and functions.

The ECB considers that certain of the proposed amendments to the EBA Regulation do not adequately distinguish between the scope of the ECB's microprudential supervisory tasks and the EBA's competence to set regulatory standards to promote supervisory convergence. It states the importance of avoiding duplication or inappropriate allocation of tasks, as this could blur the responsibilities of the two authorities and render the system less effective overall.

The ECB also makes some specific observations in the opinion concerning the revised EBA governance framework, strategic supervisory plans, stress testing and independent reviews of national competent or supervisory authorities.

A technical working document accompanied by an explanatory text is appended to the opinion, setting out the ECB's proposed amendments to the text of the proposed Regulation.

The ECB has decided to adopt separate opinions on the Commission's legislative proposals for reforms to the ESFS, so it advises that the opinion should be read in conjunction with an opinion it published in March 2018 on a proposed Regulation amending the European Systemic Risk Board (ESRB) Regulation (Regulation 1092/2010).

Joint Committee of ESAs Report on Risks and Vulnerabilities in EU Financial System

The Joint Committee of the European Supervisory Authorities ("ESAs") (that is, the EBA, EIOPA and ESMA) published its spring 2018 report (JC 2018 07) on risks and vulnerabilities in the EU financial system on April 12, 2018.

The Joint Committee identifies the following as the main risks to the EU financial system:

• Brexit. Uncertainties around the terms of the UK's withdrawal from the EU could expose the EU27 and the UK to economic and financial instability and weaken market confidence, particularly if negotiations end in a disorderly way. The lack of a conclusive agreement on the withdrawal terms could affect the legal framework for financial services and the continuity of financial contracts, and create operational challenges.
• Cyber risks. These risks threaten data integrity and business continuity and are particularly dangerous because of possible multiplier effects leading to further business risks such as supply chain risk and reputational risk. Similarly, risks related to virtual currencies and crypto-assets have recently materialised.

The Joint Committee published a report in March 2017 noting that the growing use of big data could increase the risk of harm from cyber attacks.

• Asset repricing. The risks related to valuations and repricing of risk premiums could reduce profitability and asset quality across sectors. Asset quality in the banking sector has recently improved and volumes of non-performing loans ("NPLs") disposals are increasing. However, the amount of NPLs on banks' balance sheets remains high, which needs to be addressed by banks and supervisors.

The Joint Committee's spring 2017 report on risks and vulnerabilities in the EU financial system warned that the banking sector was being affected by high levels of NPLs.

• Climate change and the transition to a lower carbon economy. This raises concerns about the sustainability of investments across large parts of the financial sector. Climate change can affect asset quality through different transmission channels, which could in turn affect the solvency position of financial institutions.

In the light of the risks identified, the Joint Committee recommends a series of policy actions by the ESAs, national competent authorities and financial institutions. These recommended actions are set out in the report.

The Joint Committee previously reported on risks and vulnerabilities in the EU financial system in September 2017.

ECB Speech on Risk Appetite Frameworks

The European Central Bank ("ECB") published a speech, "Risk appetite frameworks: good progress but still room for improvement", given by Daniele Nouy, ECB Supervisory Board Chair, at the International Conference on Banks' Risk Appetite Frameworks on April 10, 2018.

In her speech, Ms. Nouy explains that a bank's risk appetite framework includes the policies, processes, limits, controls and systems it puts in place to define, communicate and monitor how much risk it is willing to take on. Supervisors expect risk appetite frameworks to be comprehensive, effectively governed, consistently used and fully integrated into strategic decision-making.

Ms. Nouy acknowledges that banks' risk appetite frameworks are now better structured and subject to clearer governance. Most banks have clarified the role of the relevant stakeholders involved in the risk appetite framework and many banks' internal auditors have reviewed the effectiveness of risk appetite frameworks.

However, she highlights four areas in which banks need to improve:

• Banks need to improve how they embed risk appetite frameworks in their strategic processes. They need to take a holistic approach to risk culture and risk management and to align risk modifiers and key performance indicators with their risk appetite frameworks. The board must challenge the senior management and ensure that each strategic decision is based on a sound risk analysis.
• Risk appetite frameworks still do not cover enough risks, particularly non-financial risks (such as compliance and reputational risks, IT risks, legal risks and conduct risks).
• The governance of risk appetite frameworks must be improved. Boards and banks' risk functions need to play a larger role in defining and reviewing risk appetite frameworks
• Risk appetite limits need to be set and used comprehensively. Banks need to break these limits down to business lines, entities and countries and need to work on how they calculate and apply limits.

Ms. Nouy previously stated that banks' progress had been too slow in relation to risk management frameworks in a speech in March 2018.

The ECB identified risk management as one its supervisory priorities for the single supervisory mechanism ("SSM") for 2018.

ECB Consults on Cyber Resilience Oversight Expectations for FMIs

The European Central Bank ("ECB") published for consultation a draft version of the cyber resilience oversight expectations ("CROE") for financial market infrastructures ("FMIs") on April 10, 2018.

The CROE are based on guidance on cyber resilience for FMIs that was published by the Committee on Payments and Market Infrastructures ("CPMI") and the International Organization of Securities Commissions ("IOSCO") in June 2016. The 2016 guidance was immediately applicable and the CROE form part of the oversight of the guidance, setting out assessment criteria for supervisors to use.

The CROE also provides FMIs in the euro area with steps on how to implement the guidance and enhance their cyber resilience.

In line with the guidance, the CROE covers five primary risk management categories:

(i).   Governance.

(ii).  Identification.

(iii). Protection.

(iv). Detection.

(v).  Response and recovery.

It also covers three overarching components which relate to testing, situational awareness, and learning and evolving.

The CROE use a maturity model that provides supervisors and FMIs with a benchmark against which they can evaluate FMIs' current level of cyber resilience, measure progression and establish priority areas for improvement.

The webpage for the consultation invites FMIs and other interested parties to provide their input on the draft CROE. The deadline for responses is June 5, 2018.

The ECB provided an overview of the Eurosystem cyber resilience strategy for FMIs in a speech in November 2017.

Notice of Entry into Force of EU-US Bilateral Agreement on Insurance and Reinsurance Prudential Measures Published in OJ

A notice confirming the entry into force of the bilateral agreement between the EU and the US on insurance and reinsurance measures was published in the Official Journal of the EU ("OJ") on April 9, 2018.

The notice states that the US and the EU have notified each other of the completion of the procedures necessary for the entry into force of the agreement. The agreement entered into force on 4 April 2018, under Article 8 of the agreement (which provides that the agreement will enter into full force seven days after the EU and the US exchange written notifications certifying that they have completed their respective internal requirements and procedures, or on such other date as they may agree).

The EU and the US announced the signing of the agreement in September 2017 and the final text of the agreement was published in the OJ in October 2017. A decision of the Council of the EU approving the agreement was published in the OJ on April 6, 2018.

EC Publishes "New Deal for Consumers" Package

The European Commission ("EC")has published its "New Deal for Consumers" package. The package comprises 16 documents, some yet to be published.

The initiative is composed of two proposals for Directives:

A proposal for a Directive on better enforcement and modernisation of EU consumer protection rules (2018/0090 (COD)). This will amend the Unfair Contract Terms Directive (93/13/EEC), the Consumer Price Indications Directive (98/6/EC), the Unfair Commercial Practices Directive (2005/29/EC) and the Consumer Rights Directive (2011/83/EU). This proposal's aim is to ensure better enforcement and to modernise EU consumer protection rules, in particular in the light of digital developments.

A proposal for a Directive on representative actions for the protection of the collective interests of consumers (2018/0089 (COD)), dealing with representative actions for the protection of the collective interests of consumers, and repealing the Injunctions Directive (2009/22/EC). This proposal's aim is to improve the tools for stopping illegal practices and facilitating redress for consumers whose rights have been infringed.

The main themes are improved enforcement measures, better protection for online consumers, and EU harmonisation:

• The proposals will, among other things, empower qualified entities to launch representative actions on behalf of consumers and introduce stronger sanctioning powers for member state consumer authorities.
• There will be greater online protection for consumers in the form of new disclosure rules concerning the identity of traders and the existence of paid advertisements. In addition, consumers will have similar rights in respect of "free" digital services as they do in respect of paid services, such as information rights and the right to cancel within 14 days. (The latter measures are directed at digital services for which consumers provide their personal data, but do not pay with money, such as cloud storage services, social media or email accounts.)
• The new regime will also deal with the practice of offering products of differing quality but in the same format within different member states.

The next step is for the Commission's proposals to be discussed by the European Parliament and the Council.

Impact Finance

IRS and Treasury Announce First Opportunity Zone Designations

On April 9, 2018, the U.S. Treasury and the IRS designated the first "qualified opportunity zones" in 18 states. A list of the designated opportunity zones is available here.

The U.S. Tax Cuts and Jobs Act (the "Act"), signed into law on December 22, 2017, created a process to designate certain low-income community census tracts as "qualified opportunity zones." Investments in opportunity zones receive preferential tax treatment. The provision is designed to encourage investment in these low-income areas.  States were required to nominate low-income communities to be designated as qualified opportunity zones, or request a 30-day extension to submit the nominations, by March 21. The U.S. Treasury then has 30 days from the submission date to approve the designations. On April 9, the designations for all states that submitted by the March 21 deadline were announced.

Under the Act, the designated opportunity zones will retain the designation for 10 years. Tax on prior gains can be deferred until no later than December 31, 2026, so long as the gain is reinvested in a "qualified opportunity fund", an investment vehicle organized to make investments in qualified opportunity zones. In addition, if an investor holds an investment in an opportunity fund for at least 10 years, the investor is eligible for an increase in its basis. According to the U.S. Treasury press release announcing the first designated opportunity zones, U.S. Treasury and the IRS plan to issue additional information on the certification of opportunity funds under the Act.

Rating Agency Developments

On April 6, DBRS published its methodology for rating U.S. Film Rights Securitizations. Release.

On April 6, Moody's updated its methodology for rating Environmental Services and Waste Management Companies. Release.

On April 6, Moody's updated its methodology for rating European Social Housing Providers. Release.