EUROFI financial forum: strengthening economic union and European competitiveness

The Eurofi financial forum is a setting for exchanges between European Union (EU) economic and financial regulators and senior financial sector executives from the industry.  It occurs bi-annually alongside the Economic and Financial Affairs Council configuration (ECOFIN) meetings. This summary takes stock of the Eurofi discussions, as well as recent publications by the EU Commission and other EU bodies.

A packed agenda covered many varied themes and topics, including economic challenges facing Europe; European and global regulatory and supervisory priorities to support the digitalisation of financial services and to finance the green transition; and key vulnerabilities in the financial sector. These themes were all set under the umbrella of strengthening economic union and European competitiveness, fundamental requirements for enhancing the attractiveness of European financial markets, and supporting the investment necessary for the green transition.

Managing risks in the banking sector

The current and deteriorating economic headwinds (with high levels of debt, high inflation and rising interest rates) is creating a tightening credit market.  Supervisory authorities are responding by asking banks to strengthen provisioning and review residential and commercial real estate portfolio resilience.

Recent banking turmoil in the U.S. and Europe reminded us of potential fragilities in bank risk taking. The consensus was that EU/UK banking regulations performed well in the face of the turmoil. This was in part because of the widespread adoption of Basel regulations, including for small and medium-sized banks.

However, there was also a consensus that deficiencies in banks’ risk management and governance lay behind the turbulence (and that this keeps being a cause of banking failures). Therefore, the supervisory focus will be on assessing banks of all sizes and whether they have competent senior staff with integrity who create a sound risk culture to ensure bank business model viability. This observation applies as much to small and medium-sized banks as well as large banks because SMEs have fewer staff to provide checks and balances against prevailing business models and excessive risk taking.

Recent banking failures also highlighted how digitalisation and social media can exacerbate rapid deposit withdrawals. Participants noted the importance of banks having strong liquidity management and that supervisory attention should also focus on this. 

In terms of current and emerging risks impacting the banking sector, continued growth in Non-Bank Financial Intermediation (NBFI) and their role in credit granting, and liquidity and maturity transformation was a hot topic. A key concern is how NBFI can have several distinct interactions with a bank (through loans, securities, funding and derivatives), but that cumulatively this can lead to a convergence of material risks within a bank to the same NBFI entities or NBFI entities with similar risk profiles. So, banks should delve deeper into their interactions with NBFI entities and identify/model possible correlations between these activities were non-bank entities to experience financial difficulties, and then assess what this means for bank resilience.

Sustainable finance

Sustainability was a key theme throughout the Forum with several sessions dedicated to climate and environmental-related risks, how to accelerate the transition to net-zero, and sustainability reporting frameworks (in the EU and internationally).

The European Supervisory Authorities Progress Reports on Greenwashing in the financial sector, published in June, put forward a common high-level understanding of greenwashing applicable to market participants and assessed which areas of the sustainable investment value chain are more exposed to greenwashing risks. The greenwashing reports were positively received by Forum participants as helpful to understand how greenwashing risks are perceived and how those risks may (intentionally or unintentionally) materialise. This positivity was in part raised because potential accusations of greenwashing are holding back investment opportunities. Participants also mentioned how the lack of a clear definition of sustainable investment is hampering green financing.

Sustainability reporting policy and implementation priorities should be:

  • Introducing EU sustainable investment labels – this was overwhelmingly stated by many participants. While the Forum was taking place the Commission’s SFDR consultation was released.
  • Clearly defining what is a sustainable investment – this was raised in several sessions as an essential component for providing clarity and reliability for the whole EU sustainability reporting framework.
  • Helping corporates implement CSRD. Firms need flexibility when implementing CSRD because data is still poor. Corporates also need support on how to provide useful forward-looking sustainability information, which is the type of information that investors want.

The collaboration between the ISSB and ESRS on the interoperability between the two international sustainability reporting standards was widely acknowledged. High on the agenda is to provide more detailed mapping between the two regimes. Equally important is putting in place the mechanisms to enable successful adoption and implementation of the standards. With that in mind, the ISSB will be creating a Knowledge Hub containing among other things case studies and good practice guidance. A FAQs tool will be established shortly by EFRAG so that stakeholders can put forward ESRS application questions.

Focusing in on environmental risks and banks, participants noted the positive progress made by banks regarding governance frameworks and risk management practices. Banks need to continue strengthening their ESG capabilities when it comes ICAAPs, scenario analysis and risk metrics and indicators. The importance of environmental risks to banking is viewed as a reason why it may be necessary to have regular climate stress testing exercises. Looking ahead the EBA will be publishing imminently its Pillar I report on whether a dedicated prudential treatment for ESG exposures/activities would be justified.

Digitalisation of financial services and the Digital Euro

Digitalisation featured in several sessions indicating how it is dramatically impacting all aspects of financial services. Sessions covered:

  • The EU Financial data Access (FiDA) framework, which intends to extend the obligation to provide access to consumers financial data beyond payment account data. The aim is to enhance competition across market providers and facilitate innovative financial products and services that are more tailored to consumers’ needs.
  • Crypto-assets regulation – The Markets in Crypto-assets regulation (MiCAR) entered into force in June 2023 and firms are preparing for this. The International regulatory bodies, the FSB and IOSCO, have been consulting on and making recommendations that promote comprehensive regulatory frameworks for crypto-asset activities. Recommendations that jurisdictions can consider for bolstering their own regulatory and supervisory approaches. As is the case for other regulated financial services activities, effective cross-border supervisory cooperation is essential to oversee global firms.
  • Digital operational resilience – The EU’s Digital Operational Resilience Act (DORA) establishes a comprehensive framework on digital operational resilience for EU financial entities. It is expected to increase operational resilience and foster convergence in supervisory approaches for addressing ICT risks. A key feature will be an EU-wide framework for ICT providers to financial services firms who are identified as Critical Third-Party Providers.
  • The Digital Euro – The ECB is exploring whether to introduce a Digital Euro; a central bank digital currency that is an electronic equivalent to cash. Participants were generally quite sceptical as to the value-add a Digital Euro would provide compared to consumers existing payment options. There were also concerns about the high initial wallet limit proposed by the ECB and ensuring the Digital Euro is only a means of payment and not an investment store. Arguments for having a Digital Euro include the EU’s reliance on companies outside the EU for card and e-commerce transactions. This appears to suggest that, as digitisation increases, having an EU-created payments infrastructure is a longer-term by-product of having a Digital Euro. It is clear from all of the discussions that the Digital Euro concept is still at the genesis stage and there is a lot of scepticism to overcome.

Addressing Banking Union gaps and continuing to strengthen the Capital Markets Union

Agreeing on the final pieces to complete the European Banking Union remained a prominent theme.  Since the last Eurofi summit in March 2023 the Commission has published its Crisis Management and Deposit Insurance (CDMI) proposals. The objective is to improve the crisis tools used to manage the failure of medium-sized and smaller banks. The proposed rules will allow authorities to benefit from the many advantages of resolution as a key component of the crisis management toolbox compared to bank liquidation. So when a crisis occurs and when financial stability is at stake, depositors, such as citizens, businesses and public entities, at small and medium-sized banks, can continue to access their accounts.

Participants generally welcomed the Commission’s CMDI proposals and at the same time highlighted further needs. In particular, authorities being able to provide liquidity facilities to maintain confidence in a bank while it is being resolved. Furthermore, a European Deposit Insurance Scheme remains a necessary condition for a single banking market.

Capital Markets Union (CMU) continues to develop with further proposals to remove structural barriers and create a single market for financial capital. Several sessions covered measures within the EMIR review, the MiFIR review and the Retail Investment Strategy (RIS). Participants agreed that specific measures such as consolidated tapes will provide financial markets with more transparency and make them more attractive for investors.

Developing retail participation in capital markets while ensuring investor protection is widely viewed as important for improving the financial prospects of EU citizens while funding EU firms, hence the Commission’s RIS package announced in May 2023. The package is extensive and covers a wide range of measures in four main areas: i) product distribution and advice; ii) product disclosures and information; iii) investor education and access; and iv) cross-border supervisory cooperation.  It is wide-reaching scope is proposing changes to several regulations and directives. At the time of writing the proposals are at the very start of the co-legislative process and so there is ample opportunity for change. There is general support for the aim of the RIS. An early concern in the proposals raised by participants is the excessive focus on cost criteria in the ‘best interest of the client’ test (as opposed to value).

In spite of the raft of measures passing through the legislative process to deepen CMU, it is widely recognised that CMU is a long-term project and that all parties need to remain committed in order to make EU markets even more attractive for investors and firms.

The completion of the Banking Union remains a policy priority as does strengthening CMU with further measures. It is hoped that the co-legislators will make progress on CMDI and that this will spark renewed efforts to complete Banking Union in the next Commission mandate. The lack of trust between home and host authorities was raised as an ongoing concern that may hamper the future Banking Union agreement.

It’s widely recognised that strengthening the single market through finalising the Banking Union and further proposals to deepen the Capital Markets Union would improve the EU’s and EU banks’ competitiveness. These policy initiatives are also viewed as essential to enhance the attractiveness of European financial markets and mobilise the unprecedented investment required to fund the green transition.