EU regulatory outlook: ongoing and upcoming trends for the securities services industry

In the coming years, policy makers in the European Union will have to adapt their regulatory efforts to a number of challenges, of which inflation and perspectives of an economic recession will certainly remain front of mind. While the European Union is determined to reboost EU growth, notably with the completion of its sustainable finance and digital finance strategies, policy makers are shifting towards less flexibility on equivalence and international cooperation.

Reboosting EU growth

As part of its flagship initiative to build a new Capital Markets Union (CMU 2.0) and get investments and savings flowing across the EU, the European Commission has been focusing on sustainable finance and digital finance.

Sustainable finance in the European Union

Sustainable finance is a key priority of the European Commission. Several regulatory items are now coming to fruition: the EU taxonomy on environmentally sustainable economic activities, a regulation on disclosures relating to sustainable investments and sustainability risks, as well as a directive on corporate sustainability reporting.

In July 2022, the European Commission formally adopted the consolidated regulatory technical standards (RTS) of the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy Regulation. The complementary climate delegated act includes specific nuclear and gas energy activities in the climate taxonomy. These started to apply in January 2023.

The Platform on Sustainable Finance (PSF) has also proposed a list of sustainable economic activities and their associated screening criteria to support pollution prevention, circular economy, protection of marine resources, and healthy ecosystems. A consultation on corresponding draft delegated acts is expected in early 2023. The publication in the Official Journal of those delegated acts is set for Q3 2023, with an entry into application for Q4 2024.

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Digital finance in the European Union

Digital finance is paramount in the European Commission’s regulatory agenda as policy makers are committed to setting up a comprehensive regulatory framework for crypto-assets by 2024.

The DLT Pilot Regime Regulation has already entered into force and will enter into application on 23 March 2023. For market participants, the Pilot Regime is crucial to experiment with distributed ledger technology because it will allow them to request certain regulatory exemptions in order to facilitate the development of DLT market infrastructures. Experimentation is key to help ease the transition to tokenised financial instruments and DLT market infrastructures and strengthen the EU’s global competitiveness through streamlined processes.

The Markets in Crypto-assets Regulation (MiCA) is set to come into force in early 2023, with an entry into application expected in Q4 2024. MiCA aims to provide legal certainty for unregulated crypto-assets (e.g., utility tokens, stablecoins consisting of e-money tokens or asset-referenced tokens) by providing harmonised requirements for issuers of crypto-assets and crypto-asset service providers wishing to apply for an authorisation to provide services in the EU.

The Digital Operational Resilience Act (DORA) was published in the Official Journal on 23 December 2022. DORA aims to promote safer markets. Crypto firms will be fully subject to its requirements, especially regarding management of risks, hacks and technology failures.

The European Commission has also stated that it intends to propose legislation on a central bank digital currency (CBDC) – or digital euro – for the EU in the first half of 2023. Many details still lack as to what its features and function might be, but the outcome of the European Central Bank’s two-year investigation phase in autumn 2022 is expected to be published soon.

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Equivalence and international cooperation

The clearing sector is a prime example of how the EU appears increasingly less flexible on certain matters. Now that the UK has left the European Union, the EU is working on getting Euro-denominated derivatives clearing activity to move to EU-located central counterparty clearing houses (CCPs) with a view to reducing its reliance on UK-based CCPs, as exemplified by the ongoing EMIR review.

The European Commission proposed on 7 December 2022 a review of EMIR (EMIR 3.0) in order to make EU clearing more attractive. The review is also intended as a means to reduce exposure of EU financial institutions to non-EU CCPs. The proposal notably contains prescriptive measures, such as the obligation to have a mandatory active account with an EU CCP; but also incentives, such as capital charges. The European Banking Authority (EBA) and the European Systemic Risk Board (ESRB) have signaled that prudential measures should be taken against excessive exposures to Tier-2 CCPs. Allowing the two UK Tier-2 CCPs to continue offering clearing services in the EU after 2025 is viewed as something positive by both the EBA and the ESRB. The review of EMIR will also include some technical improvements to the existing regulation.

The EU has made clear that the extension allowing banks to trade through certain UK CCPs is temporary and will not continue after 2025. Higher charges for companies failing to comply with relocation in the EU will be put in place. This implies a potential increase in compliance costs and operational challenges for market players operating in both jurisdictions.

The recognition of third-country CCPs is also topical for market players. Despite significant progress during the past few months relating to (i) equivalence decisions taken by the European Commission on key jurisdictions, and (ii) the recognition by ESMA of third-country CCPs, some of them are still not recognised. Less flexibility on equivalence and international cooperation could explain why some CCPs are still not recognised – especially in India and Turkey – with potential significant negative effects for market participants (including European ones) and countries where the CCPs are located.

The United States and other jurisdictions (e.g. Canada, India, etc.) are moving to a one-day settlement cycle (T+1). In the EU, the current settlement cycle for most transactions is two business days (T+2). While a shift to a shorter settlement cycle could result in reduced market risks and costs, the industry is wary of the pressure it could create on post-trade operations, notably for global participants. The question is now whether other jurisdictions such as the UK or the EU could decide to follow a move to T+1 settlement, bearing in mind the key benefits and main challenges, notably in terms of operational complexity and existing barriers to overcome before migration. Such an analysis could be intricate to conduct without an industry-wide consultation to identify and quantify all the associated challenges.

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