At a glance 

  • The EU’s response to the COVID-19 pandemic is having an important effect on the banking and capital markets legislative agenda that we were expecting before the crisis. The re-shaping of this agenda is now becoming clearer.
  • The European Commission’s newly-updated Work Programme makes it clear that the EU will be preoccupied with crisis fighting measures for the next several months, including rapid regulatory amendments to ensure that banks and capital markets firms can finance the recovery. Beyond this, the Commission intends to return to ‘business as usual’ with its pre-existing 2020 legislative agenda as soon as it can.
  • As the EU faces a severe economic downturn, the development of the Banking Union and the Capital Markets Union might take on new life as projects to buttress the EU’s financial stability and its capacity to finance longer-term growth.

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Policymakers have been racing to respond to the risks to economic and financial activity from the COVID-19 pandemic and the subsequent lockdowns. They have announced a broad range of financial services regulatory and supervisory measures since March, with most aiming to provide near-term relief or clarification designed to help the sector operate during a sharp, and potentially deep, disruption to economic activity.

Looking beyond the immediate firefighting, however, it is now likely that COVID-19 will have an important medium-term effect on the direction of financial services policymaking that we were expecting before the pandemic. As we discussed in our 2020 Regulatory Outlook, the EU was due to propose a number of significant legislative initiatives and reviews this year relating to banking and capital markets regulation. It is now clear that the timing and circumstances of many of these initiatives will change, given their relative level of priority in the EU’s recovery strategy and the more limited capacity of officials and legislators to focus on them in the months ahead.

Specifically in EU primary legislation for banking and capital markets, a clearer path forward has emerged with the publication of the European Commission’s updated Work Programme. From this, we see three stages of legislative activity that financial services regulatory leaders should be paying close attention to: emergency action in response to COVID-19; proceeding with key initiatives that predated the pandemic; and revitalising longstanding initiatives to assist the recovery.

Emergency action to support the financial sector’s COVID-19 response 

As with financial policymakers everywhere, EU officials are keen to ensure that financial services firms remain stable during challenging market conditions, but that they also be able to continue to carry out important functions for their customers. For banks, the main policy objective has been to encourage them to continue lending to the real economy and to provide liquidity to key markets even during an economic downturn. This means allowing banks to use capital and liquidity buffers, where appropriate, and ensuring that regulatory requirements do not act pro-cyclically (i.e. exacerbating a downturn by forcing banks to constrain credit even further because of the downturn).

Much of this work was done early-on by supervisors using the discretion already at their disposal in the existing regulatory framework. The European Commission did, however propose a series of ‘Quick Fix’ emergency amendments to the Capital Requirements Regulation (CRR) in April to provide more support in the area of banking prudential requirements. These measures (which we analysed in an earlier blog) are now receiving intense focus by EU legislators as they rush to secure agreement on this package before the end of June. If the CRR Quick Fix is successfully agreed, EU officials hope that the targeted changes will rapidly provide banks with added balance sheet capacity to increase their lending within their (amended) regulatory capital constraints.

We also expect that the Commission will choose to propose further ‘Quick Fix’ amendments to other pieces of EU financial services legislation. These could focus on files such as the Markets in Financial Instruments Directive and Regulation (MiFID/MiFIR) or the Market Abuse Regulation, for instance, and include targeted changes meant to streamline investor protection rules to make them more fit for the current circumstances.

Proceeding with key initiatives that predated the pandemic

The EU’s pre-pandemic legislative priorities in banking and capital markets see some delays, but unless the public health and economic crises in Europe become more severe than is currently expected, the likely disruption to the EU’s planned legislative agenda appears to be limited.

At the beginning of the year, the European Commission was expected to propose a major revision to the CRD/CRR by June in order to implement the finalised Basel III framework in EU law. The work on CRD6/CRR3, as the forthcoming proposal is known, has now been pushed back due to the focus on COVID-19, and in response to the Basel Committee on Banking Supervision’s 27 March decision to delay the implementation of Basel III by one year to January 2023. The Commission’s updated Work Programme, however, indicates that it still intends to propose CRD6/CRR3 by the end of 2020. As we explained in April, even with the benefit of an extra year, the Commission still faces a race against the clock to adopt Basel III on time, given the lengthy EU-level political negotiations that must take place before the implementation of the new rules can proceed.

It is less clear at this stage how COVID-19 will affect key reviews of EU capital markets legislation. The Commission did extend the public consultation deadline for the review of MiFID II/MiFIR by one month to 18 May, but this should not have too substantial an effect on its work to assess the effectiveness of the MiFID framework. As part of this review, the Commission has re-confirmed its intention to report to the European Council and Parliament by the end of the year, proposing legislative changes that are needed to address any shortcomings it identifies. It is probably too early to say whether its preoccupation with the COVID-19 response will reduce the Commission’s appetite to make large-scale amendments to MiFID/MiFIR, but this cannot be ruled out at this stage.

In other areas, the Commission has made clear that it sees some pillars of its financial services agenda as a critical part of the EU’s pandemic recovery strategy. In line with this, Commission officials have said that they do not intend to delay work on initiatives related to their Digital Finance and Retail Payments Strategy. The new Work Programme does forecast a small delay to the EU’s Renewed Sustainable Finance Strategy, but we should nevertheless still expect to see this by Q4 2020. The Commission has also reconfirmed its intention to press forward with work on cyber and IT security in the financial sector, leading to a legislative proposal to create an EU Digital Operational Resilience Framework, which is still due to be tabled in Q3 2020. Such a fast approach to tabling legislation, however, may not give the Commission very much time to reflect on the lessons-learned from the pandemic and how it could incorporate them into the proposals it makes. In this case, and especially as concerns the digital operational resilience legislation, it will likely fall to the deliberations of the European Council and Parliament to ensure proper consideration is given to the financial sector’s challenges and successes observed during the COVID-19 lockdowns.

Revitalising longstanding initiatives to assist the recovery 

As the pandemic recovery takes hold and more progress is made on 2020’s key legislative priorities, it is worth considering the effect that COVID-19 will have on the EU’s longer-term efforts to strengthen the Single Market for financial services.

The EU has two large, ongoing and unfinished projects borne out of the last financial crisis and the Eurozone debt crisis that followed: the Banking Union and the Capital Markets Union (CMU). Both made critical progress early-on, but have since made comparatively fewer advances. The Commission, however, may feel that the EU’s COVID-19 recovery strategy is the perfect opportunity to help these projects regain momentum.

For the Banking Union, the establishment of a Eurozone-wide deposit insurance scheme and agreeing to provide a central fiscal backstop for the Single Resolution Fund have made little legislative headway since 2015. But now, a sharp economic contraction could threaten the stability of banks in some EU countries with an increase in non-performing loans over the next several years. Facing this, and remembering the contagious effect that weakness in one country’s banks had across borders a decade ago, EU policymakers may renew their efforts to complete the final pillars of the Banking Union to maintain confidence in the long-term soundness of the continent’s banking system. Progress on this has traditionally come very slowly, but recent strides made by EU Member States to develop unprecedented fiscal measures to assist in the economic recovery may also translate into more willingness to strengthen the Banking Union’s risk‑sharing infrastructure.

For the CMU, 2020 was always going to be a year of re-invention. Recognising the need to re-invigorate the capital markets agenda, the CMU High Level Forum (HLF) was convened by EU policymakers in 2019 to identify those areas where legislators could most usefully standardise rules and practices, and to develop these recommendations into a new CMU Action Plan to be adopted by the end of 2020. With the EU now facing an economic downturn, the Commission has pointed to the CMU as a key vehicle for financing the EU’s recovery through encouraging cross-border investment, boosting investor protection and reducing administrative barriers within the Single Market.  The June HLF report is likely to give us some indication of whether the Commission’s early thinking on the link between the COVID-19 recovery and the CMU will translate into a substantially more ambitious set of initiatives in the CMU Action Plan. But the Commission has already taken a step in this direction with its unexpected consultation this week on an Investment Protection and Facilitation Framework. Projects such as these, however, will likely take years to be negotiated and implemented, in which case they will be of no practical value in assisting the EU’s economic recovery this year and next.

Making meaningful progress on the completion of the Banking Union and CMU has appeared far-fetched in recent years. It is worth remembering, however, that the EU’s biggest institutional leaps forward and its most pragmatic solutions in the integration of its banking and capital markets have often been driven by its response to past crises. The scale of the economic and financial challenges that follow the COVID-19 crisis may give the EU another such opportunity, once the immediate firefighting ends.