EUROPEAN COMMISSION Brussels, 23.11.2016 SWD(2016) 359 final COMMISSION STAFF WORKING DOCUMENT on the Call for Evidence Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE REGIONS Call for Evidence - EU regulatory framework for financial services {COM(2016) 855 final}



Staff Working Document on the Call for Evidence Contents 1.Introduction 1.1.Commitment to Better Regulation 1.2.The Call for Evidence and Capital Markets Union 1.3.Key messages 2.Reducing unnecessary regulatory constraints on financing The economy 2.1.Banks' ability to finance the wider economy 2.2.SME financing 2.3.Long-term investment 2.4.Market liquidity and trading 2.5.Access to clearing 3.Enhancing proportionality of rules without compromising prudential objectives 3.1.Proportionality in banking rules 3.2.Proportionality in derivatives markets 3.3.Proportionality in insurance 3.4.Proportionality in other sectors 4.Reducing undue regulatory burden 4.1Supervisory reporting requirements

4.2.Public disclosure requirements 4.3.Compliance costs 4.4.Barriers to entry 5.Making the regulatory framework more consistent and forward-looking 5.1.Unintended interactions and inconsistencies between legislations 5.2.Retail investor and consumer protection 5.3.Gaps and remaining risks in the regulatory system 5.4.Technological developments 1.Introduction 1.1.Commitment to Better Regulation The Commission Communication on “Better Regulation: Delivering better results for a stronger Union”, published on 14 September 2016, stated that well-targeted, evidence-based and simple regulation is more likely to achieve its goals. More effective regulation, which addresses European market failures, should also be proportionate, to avoid undue burden on citizens, businesses and public authorities. In effect, better regulation requires rules with a focus on their expected effects. The Commission already evaluates the performance of existing EU regulation before assessing the potential impact of options for new rules and holds open public consultations to evaluate whether action already taken or options for future action are best taken at European level or the objective could be better achieved by Member States. Since 2003, when impact assessments became the norm, the Commission has prepared 975 impact assessments to support its proposals. Since 2010, the Commission has also run 704 public consultations and made 688 ex post evaluations of EU legislation. Evaluations, impact assessments and public consultations are essential ingredients of the Commission's Better Regulation agenda. Better regulation tools can deliver more proportionate rules and minimise unnecessary costs, as well as address interests and concerns identified by stakeholders and the general public. Significant financial sector reforms have been achieved since the crisis, including the single supervisory and single resolution mechanism for the banking union, bank resolution tools, greater deposit protection, new supervisory authorities and an improved regulatory framework for banks, insurance companies, financial markets and other sectors. Overall, these reforms have made the financial system more resilient. Nonetheless, the complexity of this regulatory effort requires an overall assessment of its coherence and consistency with their ultimate objectives. With the call for evidence, the Commission has taken its better regulation methodology a step further by looking across the entire body of financial services regulation and assessing interactions between individual pieces of legislation. In the spirit of the better regulation agenda, asking for evidence-based policy making, the call for evidence invited external stakeholders to provide data and practical experiences about the combined impact of rules. EU legislation should ultimately remain efficient, consistent and coherent with the objective of balancing financial stability with a growth friendly regulatory framework that protects investors properly. The call for evidence is in line with the European Parliament’s Resolution "Stocktaking and challenges of the EU Financial Services Regulation: impact and the way forward towards a more efficient and effective EU framework for Financial". The results of this effort have fed into the work of international fora, such as the G-20, the Financial Stability Board, and the Basel Committee on Banking Supervision (BCBS), which are assessing the overall coherence of the reforms undertaken globally. The EU is the first jurisdiction to have launched such a comprehensive and structured approach in financial services regulation. The call for evidence gathers evidence to fine-tune the implementation of the post-crisis reforms in the light of initial experience, not to question the main aspects of the reforms. 1.2.The Call for Evidence and Capital Markets Union The call for evidence complements one of the Commission’s flagship initiatives, the Capital Markets Union (CMU). CMU aims to diversify the financial system with alternative funding tools to traditional banking services. It aims to complement bank funding in the EU with stronger capital markets. A more balanced distribution of financing sources should ultimately strengthen financial stability even further and facilitate the access of businesses to a source of financing that is most suited to their particular situation and needs. It should also create more and better opportunities for investors, deepen financial integration and increase competition in the financial services industry. The call for evidence aims at improving the quality of the current regulatory framework in financial services, including those that will be directly impacted by CMU actions. It was thus meant to verify that financial reforms do not unduly burden access to finance and that they are consistent across financial sectors and coherent in a way that major regulatory gaps are addressed. To address barriers to finance and unintended consequences, the call for evidence supports CMU actions with additional input to make appropriate adjustments to the regulatory framework. 1.3.Key messages

The call for evidence attracted a large amount of interest, with around 300 respondents having shared their observations and concerns. As summarised in the call for evidence Summary Feedback Statement, around 80% of the responses came from the financial industry with the remainder, among others, coming from the public authorities, consumer organisations, NGOs, think-tanks and private individuals. In terms of number of issues raised, capital markets formed the second most prominent topic, following bank regulation. Many of the issues raised are closely aligned with the objectives of the CMU, such as facilitating better access to finance or reducing barriers to cross-border investments. Overall, stakeholders did not dispute the fundamental aspects of the recent financial reforms. In fact, many expressed support or highlighted the benefits of the new rules, which have enhanced the stability and resilience of the financial system. Stakeholders welcomed this exercise as an important step in improving the existing regulatory framework to strike the right balance between economic growth and financial stability. Although the exercise originally focused on the legislation adopted by the co-legislators that is already in force, many responses were submitted on the possible impact of measures that are still being formulated (e.g. as regards the ongoing work of the BCBS). These were included in the report, but the evidence on the impact of rules not yet implemented is limited. The call for evidence has proved to be very useful in drawing attention to examples of inconsistencies, overlaps and unintended interactions between different pieces of legislation. As set out in the consultation documents, the responses to the call for evidence were assessed against the following objectives: promoting economic and financial stability in the EU; maximising the benefits of the financial system to the economy, jobs and sustainable growth, and promoting better access to finance, notably for SMEs; completing the EU single rulebook and promoting the single market; restoring trust in the financial system and ensuring a high level of consumer and investor protection; ensuring the EU rules are as simple and clear as possible and keeping regulatory burden to the minimum necessary; and promoting competitiveness of the EU economy. Based on a thorough review of all the consultation responses and the evidence provided, the public hearing in May 2016 and the subsequent analysis by the Commission services, it has concluded that follow-up actions are required in the following areas: Greater attention should be paid to areas where rules may be impeding the flow of finance to the economy. Consideration needs to me made as to whether the same prudential objectives can be achieved in a more growth friendly way. (Chapter 2) There may be scope to increase the proportionality of the regulatory framework as part of the wider aim to better balance financial stability and growth objectives. Rules should recognise the diversity of financial institutions in the EU and should not create unintended barriers to new market players. (Chapter 3) Unnecessary regulatory burdens should be avoided, and rules designed that achieve their objectives at minimum cost for firms and, ultimately, end users and the wider economy. In particular, the burden stemming from duplications and inconsistencies of the various individual requirements should be assessed. (Chapter 4) Unintended interactions and inconsistencies need to be looked at with a view to addressing the remaining risks in the financial system, further enhancing investor trust and consumer protection and keeping the regulatory framework up to speed with technological development. (Chapter 5) In addition to initiating new follow-up actions, notably to fill the remaining gaps in the regulatory framework, the additional insights and evidence gathered through this consultation will be used for several ongoing work streams, such as: Fitness checks and legislative reviews as part of REFIT, including on reporting requirements in the financial sector; Calibrating of the measures at both the legislative and implementation levels; Ongoing policy work, e.g. to refine and accelerate measures under the CMU Action Plan; and Commission input into efforts at global level to measure and evaluate the combined effect of reforms. This Staff Working Document accompanies the Communication on the call for evidence which sets out the follow-up actions that the Commission intends to take. It provides background information for the Communication but does not contain any new policy commitment for the Commission beyond what is set out in the Communication.





2.Reducing unnecessary regulatory constraints on financing The economy The financial system plays an important role in helping households and firms to manage financial risks over time and execute payments, which contribute to make the environment more investment friendly. Post-crisis financial reforms aimed at strengthening the resilience of the financial system and its diversification to better withstand shocks that hamper access to finance, as during the financial crisis. Rules, however, can create unintended interactions that may impede the flow of finance to the economy. It is therefore important to assess whether rules can achieve the same prudential objectives in a way that minimises the impact on access to finance for firms and households. This section reviews submissions arguing that EU rules may hinder access to finance in the following areas: banking activities (section 2.1); SMEs financing and long-term investments (sections 2.2 and 2.3 respectively); market liquidity (section 2.4) and clearing services (section 2.5). 2.1.Banks' ability to finance the wider economy Firms and households in the EU remain highly dependent on banks' capacity and willingness to finance their investments and activities. While the Commission is working with the co-legislators to develop the CMU so as to broaden the sources of finance, it is imperative that the bank funding channel functions appropriately. Most respondents agreed that the post-crisis reforms steered by the BCBS and implemented in the EU through the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD IV) were crucial in restoring the resilience of the banking sector. Such resilience is a pre-condition for banks to play their role in financing the economy. However, respondents also expressed concerns about the impact of upcoming prudential measures being finalised by the BCBS, and how they may interact with existing rules in a way that limits the financing capacity of banks. Banks have raised over €800bn of capital since the financial crisis. The 2016 stress test of the European Banking Authority (EBA) also showed that Europe's banking system is able to withstand severe shocks. The Commission's focus is now to implement the remaining BCBS reforms to address remaining risks in a way that ensures that banks maintain the capacity to support the growth of the EU economy. Submissions focused on three major pillars of EU bank legislation: CRR, CRD IV and the Bank Recovery and Resolution Directive (BRRD). The first sub-section takes stock of issues raised in the context of prudential measures foreseen in the review of the CRR and CRD IV. The second sub-section assesses concerns about the way so-called "Pillar 2" bank capital requirement rules are applied. The third sub-section reflects on whether the prudential rules should be adjusted in light of the banking union, whereas the final sub-section considers concerns about a particular aspect of the bail-in regime under BRRD. A) Prudential measures In reaction to the financial crisis, governments, central banks as well as supervisors strengthened the international regulatory framework for banks through the Basel III reform agreed in 2010. In the EU, Basel III was implemented by means of the CRR/CRD IV package, which introduced stricter rules on capital requirements for banks and laid the ground for implementing the international standards on liquidity and leverage. A large number of responses to the call for evidence concerned the CRR/CRD IV package including those that are currently under discussion internationally. 1.Leverage ratio (LR) reduces diversity in the EU financial sector. Respondents stated the LR endangers diversity in the EU financial sector by reducing the capacity of low-risk business models (e.g. public development banks, mortgage banks, banks with mainly sovereign exposures) to compete with higher-risk business models. 2.Net Stable Funding Ratio (NSFR) impact on repo markets and market making activities. Respondents argued that short term transactions with other financial counterparties, such as repo/reverse repo, would suffer from an asymmetric treatment under the NSFR Basel proposal. Short term borrowing transactions from financial counterparties receive a 0% Available Stable Funding (ASF) factor, whereas short term lending transactions with financial counterparties receive a 10% or 15% Required Stable Funding (RSF) factor. Respondents argued that this could be detrimental to the repo market and to market-making activities in the underlying repo's collateral (sovereign bonds, corporate bonds, etc.) given that well-functioning repo markets are essential for banks' ability to manage liquidity and market-making related inventory, and therefore to the market liquidity of this underlying repo's collateral.

3.NSFR impact on derivatives activities. Respondents argued that the NSFR's lack of risk sensitivity and treatment of margins would penalise derivatives activities and reduce end-users ability to hedge risks. Respondents contended that this would result in important stable funding requirements for EU banks on their offering of risk hedging tools to credit institutions and end-users, including corporates, and hence may incentivise them to reduce the offer or shift additional costs to end-users. 4.LR impact on clearing services: Banks acting as clearing members argued that, if the LR were not to allow the initial cash margins received from clients to reduce the potential future exposure on the client leg of the centrally cleared client derivative transaction, then this would result in a disproportionate increase in capital requirements for this low margin business. They argued that this could adversely affect the provision of central clearing services to clients, which is contrary to the G20 objective of promoting central clearing (see also section 2.5). 5.Trade finance under the NSFR/LR. Respondents argued that trade finance loans are less risky than standard corporate loans, but this lower risk is not fully reflected in existing or forthcoming requirements. As regards the former, they expressed concern that some of the rules on how banks have to measure risks when using internal ratings-based (IRB) approaches unduly penalise trade finance. On the latter, they voiced concerns that neither the LR nor the NSFR would recognise the particular nature of trade finance, calling for specific adjustments, such as lower NSFR RSF factor or exempting trade finance from calculation of the LR. 6.LR – Liquidity Coverage Ratio (LCR) interaction. Some respondents referred to potential adverse interactions between the LR and the LCR. The LR penalises banks for holding High Quality Liquid Assets (HQLA), which are required by the LCR. While conceptually valid, the LCR and LR pursue different prudential objectives (liquidity and capital), which credit institutions have to meet in parallel. The EBA concluded in its report on the LR that correlations between the LCR and the LR are very weak and that many institutions manage to hold significant buffers on top of all prudential requirements at the same time. 7.Impact of BCBS work on reducing excessive variability in risk weighted assets (RWA). Concerns were also raised on the upcoming calibration of the revisions at the BCBS level to tackle the excessive variability in risk-weighted assets, through the use of floors, amendments to the approaches for credit and operational risk and the Fundamental Review of the Trading Book (FRTB). Concerns were raised that these measures would significantly increase capital requirements, which would be reinforced by a similar complementary increase in TLAC requirements. These increased capital and bail-in requirements could have an unwarranted effect on funding costs and loan supply by banks. These concerns should be considered against the background of the Group of Central Bank Governors and Heads of Supervision (GHOS) statement that the BCBS will focus on not significantly increasing overall capital requirements. That ambition is shared by the Commission and Member States alike, as highlighted by the ECOFIN conclusions of July 2016. Some of the concerns raised have, where appropriate, fed into the preparation of the CRR2 package, which contains targeted measures to reflect the warranted concerns that have been raised in the call for evidence. Whilst it is true that for banks with overall low risk weights, the LR may indeed become the most constraining capital requirement measure, the LR is a non-risk sensitive measure. As stated by the EBA, the LR and the risk-based capital requirements should function in a complementary manner, with the LR defining a minimum backstop of capital to total exposure requirement through the cycle and the capital ratios allocating capital on a risk sensitive basis. Exempting certain exposures (based on risk sensitivity) from the LR or reducing the calibration of the LR for certain business models might reduce the effectiveness of the LR as a backstop measure. Nevertheless, there are cases where some adjustments are warranted, such as public development banks' lending to the public sector and pass-through promotional loans. These banks are subject to legal constraints on their business models and thus have less discretion to manage their balance sheet or income compared to universal banks that can freely choose their business model. In those cases, the LR ratio as proposed by the BCBS may have an undesirable adverse impact on the access to finance. As a result, in the CRR2 package, the Commission proposes to exclude from the LR exposure measure: public development loans and pass-through promotional loans provided by public development banks set up by a Member State, central or regional government or municipality. Second, as well-functioning repo markets are important for both market-making on the underlying collateral and liquidity management of banks, a recalibration of the stable funding requirements for short-term transactions with financial institutions compared to the Basel NSFR treatment has been proposed, subject to a review clause. Third, the Basel treatment of derivatives under the NSFR, in particular the 20% RSF factor that applies to gross derivatives liabilities and the treatment of variation margins received, has been amended in the CRR2 package proposal in order not to hinder the functioning of EU financial markets and the provision of risk hedging tools to credit institutions and end-users. Fourth, as regards the LR, the BCBS agreed that initial margin cannot offset the potential future exposure of derivative exposures that a bank centrally clears on a client’s behalf. The CRR2 package proposal will allow the deduction of these initial margins so as not to undermine the provision of central clearing services by institutions to clients. Finally, as regards trade finance, the EBA recommends a specific treatment in the NSFR, as these short-term transactions are less likely to be rolled-over than other types of loan to non-financial counterparties. As regards the LR, short term trade finance exposures, such as letters of credit, are often subject to higher capital charges under the risk-based framework, so the LR would not be constraining compared to the risk-weighted capital requirements. However, this is different for export credits guaranteed by sovereigns or export credit agencies which receive a considerably lower risk weight. In such instances, the leverage ratio would be a constraining capital requirement, leading to higher capital charges. Given these considerations, the Basel NSFR has been slightly amended in the CRR2 proposal to incorporate a specific treatment for trade finance activities, whilst export credits guaranteed by sovereigns or export credit agencies will be excluded from the proposed LR. B) Pillar 2 requirements Bank capital requirements stem from three distinct categories: (1)"Minimum" requirements applicable to all banks (so-called Pillar 1 capital requirements); (2)Additional capital requirements imposed on individual institutions by supervisors for risks not covered or not sufficiently covered by Pillar 1 (so-called Pillar 2 capital requirements); and (3)The combination of various buffer requirements related to certain risks applicable to all institutions or a subset of institutions (so-called combined buffer requirement).

Responses to the call for evidence as well as responses to the public consultation on the CRR/CRD IV and results of the EBA's monitoring of existing supervisory practices highlight that Pillar 2 capital requirements are an important determinant of an institution’s overall level of capital. Competent authorities adopt different approaches to determining and applying Pillar 2 capital requirements, which raise concern both in terms of legal certainty for investors and level-playing field. Respondents also voiced concerns about the relation between Pillar 1, Pillar 2 and buffer capital requirements (so called "stacking order" of capital requirements) and the impact they may have on the automatic restrictions on earnings distribution, foreseen when buffer capital requirements are breached. Moreover, it is argued that the current CRD and CRR rules allow for different interpretations of how Pillar 2 capital requirements may be imposed and their relationship with Pillar 1 and buffer requirements. This may result in different amounts of (Pillar 2) capital imposed on individual banks across Member States, which have an impact on the Maximum Distributable Amount (MDA) trigger. In addition, banks are not obliged to publicly disclose the level of Pillar 2 capital requirements, although they can be invited by supervisors to do so. If not disclosed, investors including those in Additional Tier 1 (AT1) instruments cannot predict when the restriction on distributions may be triggered (MDA restrictions). An institution will typically hold more capital than required to ensure that there is adequate margin to avoid any breach of the combined buffer. If, however, the competent authority suspects that an institution may not be able to meet its capital requirements at all times, it may provide Pillar 2 'capital guidance' to the institution. Respondents argued that the nature of such guidance should be clearer. As 'capital guidance' is not a formal requirement, automatic and immediate consequences in terms of restrictions on earnings would not apply for institutions operating below the guidance level, but still above the combined buffer capital requirement. Finally, respondents also argued that it may be appropriate to consider a more effective use of the combined buffer requirement in practice. In the CRR2 package, the Commission proposes to disclose additional Pillar 2 capital requirements imposed by supervisors and clarifies some aspects of Pillar 2 capital requirements, including the "stacking order", by: (i) distinguishing more clearly between Pillar 1 (applicable to all banks) and Pillar 2 (bank specific) capital requirements; (ii) clarifying the difference between Pillar 2 capital requirements (to be met by the bank at all times and subject to public disclosure) and Pillar 2 capital guidance (which implies an expectation that the institution has additional capital beyond mandatory capital requirements); (iii) clarifying that the MDA shall be calculated by taking into account Pillar 1, Pillar 2 and buffer capital requirements (but not the Pillar 2 capital guidance) and that the AT1 instruments should be given priority if, as a result of the MDA calculation, distributions have to be limited. C) Adjusting prudential rules in light of the Banking Union Respondents argued that the level of application of prudential requirements and the exercise of supervisory options should be adapted in light of the Banking Union. Bank prudential requirements apply at both consolidated (group) level and at the level of individual subsidiaries. However, they can be waived in certain instances. For example, the application of capital requirements to a subsidiary can be waived, if located in the same Member State as the parent institution. Moreover, since January 2015, the application of liquidity requirements at individual level can be waived for institutions authorised in several Member States under certain conditions. Some respondents argue that the conditions governing these waivers are too strict and fragment capital and liquidity in the single market. Some claim that the possibility to establish cross-border liquidity sub-groups and waive individual liquidity requirements so far has been of limited practical effect. They therefore argue that the waivers, as well as the exercise of supervisory options, should be adapted in light of the Banking Union, so that the euro-area is considered as one jurisdiction. The financial crisis has led many banks to reduce cross-border activities and refocus on home markets and core activities. In some instances, this fragmentation may have been amplified by national supervisors' attempt to ring-fencing capital, liquidity and funding to protect national depositors and ensure continuity of national activity. However, the establishment of the Banking Union might warrant a review of the conditions governing the waiver of the application of prudential requirements at an individual level for entities that are supervised at a consolidated level across the banking union. In fact, those entities are also subject to the Single Resolution Mechanism (SRM), which provides for a common system and centralised decision-making for resolving banks and paying for resolution. There is accordingly a degree of pooled resources for managing the fiscal consequences of bank failures, as well as harmonised rules and supervision. In light of progress made on the Banking Union, the Commission is proposing in the CRR2 package measures that have the potential to foster the integration of cross border banking in the Banking Union area, subject to appropriate safeguards. This could potentially improve the ability of cross-border banks to manage capital and liquidity within the group, reduce fragmentation and enhance banks’ capacity to finance the economy. D) BRRD bail-in recognition language (Art. 55) Respondents have raised practical concerns with Article 55 of the Directive 2014/59/EU establishing a framework for the recovery and resolution (BRRD). The BRRD requires banks to include a clause in their contracts with third country counterparties governed by the law of a third country, by which the creditor recognises the bail-in power of EU-resolution authorities. This obligation is particularly relevant for branches of EU banks in third countries, as their business is usually governed by contracts under local law. Respondents argued that banks encounter two types of difficulties when seeking to comply with Article 55 BRRD. First, certain non-EU counterparties refuse to include a contractual clause recognising an EU bail-in power, applying their own or standard internationally agreed contractual terms in their banking contracts, e.g. liabilities to non-EU financial market infrastructures, trade finance liabilities (letters of credit, bank guarantees and performance bonds). As banks often lack the means to force their counterparties to accept these clauses, the only way to comply with Article 55 would be not to enter into a contract at all. Second, even if non-EU counterparties are prepared to accept such clauses in their contracts with EU-banks, in some cases the local supervisor may not allow it. Another related issue is the wide scope of Article 55 applying to all liabilities but those excluded from bail-in and eligible deposits. The consequence is that, in some cases, it would practically prevent banks from operating in third countries. In order to comply, banks would either have to adopt costly structural measures, such as converting their branches in third countries into subsidiaries, or completely discontinue certain business activities. To achieve a credible resolution regime, there must be reassurance that global institutions can be resolved in an orderly manner without causing disruptions to the financial system and to the economy in general. This is only possible if institutions hold sufficient liabilities that can actually be bailed-in in resolution. In this spirit, the EU agreed initially on a broadly worded provision (Article 55 of BRRD), whereby any liability, which is subject to the law of a third country would not escape the normal loss absorption cascade in resolution, and therefore, would not be treated more favourably than other liabilities of the same type only for the reason that they are not subject to EU law. Yet, this should not be seen as a one-size-fits-all approach. A series of instruments, including trade finance, are of the utmost importance for international trade, in particular, for small and medium sized EU companies. In this regard, Article 55 should not worsen access of European manufacturers and service providers to trade finance instruments, which would weaken their competitiveness in international markets with potential adverse economic effects in the EU. In order to quantify the possible issues, the Commission services gathered further evidence and carried out an analysis. The conclusions are that the issue on subordinated and senior debt governed by non EU law is generally sizable for parts of the industry, but there are large divergences across individual firms. For contingent liabilities arising from e.g. trade finance products (e.g. letters of credit), liabilities vis-a-vis Financial Market Infrastructures/Central Counterparties (FMIs/Central counterparty clearing houses "CCPs") and derivatives contracts, it may be that the costs outweigh the benefits of imposing this contractual recognition. The Commission therefore proposes to amend Article 55 of the BRRD to ensure that resolution authorities can apply the requirement for contractual recognition of bail-in provisions for non-EU creditors in a pragmatic manner. The authority can exclude the obligation by means of a waiver, if it determines that this would not impede the resolvability of the bank and that it is legally, contractually or economically impracticable for banks to include the bail-in recognition clause for certain liabilities. In these cases, those liabilities should not count as MREL and should rank senior to MREL to minimize the risk of breaching the No-Creditor-Worse-Off (NCWO) principle. 2.2.SME financing Small and Medium-sized Enterprises (SMEs) are the backbone of the EU economy and the main source of employment and growth. They largely rely on bank credit to finance their activities (in particular, short-term credit lines and leasing). To date, other sources of financing, such as equity and debt capital markets, are not widely available but mainly limited to large companies and/or companies in countries with larger capital markets.

A) Bank lending As regards bank lending to SMEs, respondents advocated continuation of the current supporting factor (SF) for loans to SMEs and extension of capital relief to banks’ investments in bonds and equities issued by SMEs. The European Parliament also called on the Commission to examine the possibility of recalibrating the supporting factor, including size and threshold, and to examine possible interactions with other regulatory requirements, in a Resolution on Access to finance for SMEs which was adopted on 15 September 2016. Under the Basel rules, SME loans are subject to lower capital requirements than loans to large enterprises, either because they can be classified as retail exposures or due to their reduced size when they are allocated to corporate exposure. When classified as retail exposures, SME loans attract a flat risk-weight of 75% under the Standardized Approach (SA) and a reduced correlation coefficient under the Internal Ratings Based (IRB) Approach. When classified as corporate exposures under the IRB Approach, SME exposures nevertheless receive a lower capital requirement on the basis of a factor which depends on their size. Moreover, in order to avoid abruption of bank lending to SMEs in light of the overall increase in the minimum required capital requirements for banks the CRR introduced a SF on these Basel rules resulting in a capital reduction of 24% for SME loans below EUR 1.5 million. Currently, bank loans below EUR 1,5 million to SMEs receive a reduction in capital requirements compared to loans to larger enterprises. In the CRR2 package, the Commission is proposing to extend the ‘SME supporting factor’ to all SME loans, including those larger than EUR 1,5 million on the basis of evidence obtained on the actual riskiness of SME loans over the whole economic cycle, while ensuring that minimum capital requirements remain consistent with the riskiness of SME loans. B) Market financing Respondents broadly supported the reforms to capital market regulation. They however expressed concerns about how the market abuse, prospectus and securities market legislation affects market financing of SMEs. Market abuse regime and SME growth markets. Some respondents argued that the market abuse regime places a high burden on issuers in SME growth markets, which may ultimately result in less activity and thus reduced financing for SMEs. Particular concerns relate to the widening of scope of issuers' duties under the Market Abuse Directive and Market Abuse Regulation (MAD/R) regime to companies listed on Multilateral Trading Facilities (MTFs), such as providing insider lists and notifying managers' transactions. Several elements should be taken into consideration when assessing stakeholders' concerns: (i) under certain conditions, SME growth market issuers are already exempted from certain requirements, like the special regime for drawing up an insider list, and (ii) as per experience of the competent supervisory authorities across the EU, the majority of cases of market abuse involve issuers of a smaller size. The Commission services therefore consider that the alleviated burden for SME growth market issuers has been carefully set to strike the balance between encouraging SMEs to join these trading venues and protecting investors. The Commission services will closely monitor market developments to ensure that the balance holds in practice once the SME growth markets are operational. Prospectus Directive. Stakeholders argued that the prospectus requirements for issuers are too burdensome and raise the cost of access to capital markets, in particular for smaller companies. In November 2015, the Commission issued a proposal to revamp the Prospectus Directive, which is under negotiation. MiFID inducement rules and investment research in SMEs. Trade execution services and investment research are frequently sold as a bundle to portfolio managers, whereby the research is generally offered as a secondary feature to make the offering of the trade execution service more attractive. In the Commission Delegated Directive research can be paid for in one of two ways: (1) out of manager's own resources or (2) from a research payment account, separately and unbundled from commissions for the trade execution service. Other operational arrangements for the collection of the client research charge, whereby payment for research is collected alongside a transaction commission, will be allowed if the arrangements comply with specific conditions. Some respondents argued that these rules will impede the provision of research, especially in the area of SMEs. Furthermore, it was claimed that the price of SME research would increase, as it would have to be budgeted independently. As part of the broader work on SME financing and listing, the Commission will assess the implementation of the rules under the Markets in Financial Instruments Directive (MiFID II) on investment research in relation to SMEs. While the changes overall are expected to reduce conflicts of interest and improve the functioning of the market, the effect of the rules on the provision of SME research needs to be monitored closely. C) Prudential treatment of leases Some stakeholders raised concerns on the new International Financial Reporting Standards 16 (IFRS) on lease accounting issued by the IASB in January 2016, which is currently in the endorsement process in the EU. The standard introduces a new asset category, i.e. the right to use a leased asset. It does not however explicitly specify whether such rights are tangible or intangible assets in the financial statements. This lack of clarity is viewed as problematic by some respondents because prudential rules require different levels of capital for different asset categories, with intangible assets to be deducted fully from the highest quality of regulatory capital with a potentially high adverse impact on capital ratios. The Commission services will invite the EBA to follow this issue, taking into account the views of the Basel Committee. 2.3.Long-term investment Many respondents argued that regulation may reduce financial institutions' ability to finance long-term investments, in particular infrastructure investments. Most respondents focused on insurance legislation (Solvency II) and bank legislation (CRR/D). However, respondents also highlighted legislation governing certain funds (Regulation on European Long term Investment Funds, ELTIFs), accounting rules and taxation as factors deterring more long-term investments.

A) Solvency II impact on long-term investment Respondents expressed two concerns on how Solvency II may limit insurance companies' ability to finance long-term investments: volatility of valuation and high capital charges. As regards volatility, respondents argued that the market-based valuation of the one-year risk measure framework for assets and liabilities can create significant balance-sheet volatility, when the asset/liability management is not fully reflected in the valuation approach. This volatility increases during periods of market stress, especially for long-term debt, because capital requirements increase with duration. Insurers will have to hold capital buffers to cope with both balance sheet volatility and solvency capital requirements. Respondents argued that this can incentivise insurers to exhibit pro-cyclical behaviour by too quickly disposing of these long-term assets in a bearish market environment. While the respondents acknowledged that the co-legislators have agreed on the long-term guarantees measures package that partly mitigates volatility, they argued for relaxing the conditions for its application. For example, the conditions for this matching adjustment might be too limiting and they only partially mitigate market movements (by not mitigating default spreads). Furthermore, respondents argued that capital charges on specific assets are above the actual risks that these assets create for insurers. Respondents argued that their long-term investment perspective should be better reflected in the methodology for calibrating capital requirements. The issue is particularly important for illiquid assets such as infrastructure, private placements and SME loans, which have no market price. Finally, respondents also called for a review of risk calibrations for other asset classes (Commercial mortgage-backed securities "CMBS", real estate, strategic equity participations, private equity, securitisation, etc.). In the Solvency II framework, the long-term guarantees package provides for a set of measures that mitigate artificial balance sheet volatility. The conditions for the application of these measures are designed to preserve an adequate level of risk-sensitivity. The legislators have scheduled a review of the long-term guarantees package, and the European Insurance and Occupational Pensions Authority (EIOPA) is tasked to deliver annual reports on the impact of the framework. The Commission services will carefully follow any indications on excessive volatility and pro-cyclical behaviour, with a view to alleviate these issues where appropriate. The Commission will also assess the prudential treatment of private equity and privately placed debt in Solvency II to evaluate if this constitutes an impediment to investments. Action as regards the calibration of simple, transparent and standardised securitisation will depend on the timing of co-legislators' agreement on a framework for simple, transparent and standardised securitisation. B) Infrastructure investments Encouraging investments in infrastructure, in particular from insurance companies and banks, is part of the Investment Plan for Europe's to stimulate investments and growth in the European Union. A targeted, risk-sensitive treatment of long-term infrastructure investments subject to prudential criteria under Solvency II and CRR can play an important role. As part of the CMU Action Plan launched on 30 September 2015, and based on expert advice from EIOPA, the Commission lowered risk charges for 'qualifying infrastructure projects'. The risk calibration for investment in unlisted equity shares of such projects has been reduced from 49% to 30%. Risk charges for investments in infrastructure debt were also reduced by up to 40%, depending on the credit worthiness. Whereas these changes were welcomed, some stakeholders nevertheless called for an extension of this new measure to infrastructure corporates. As regards the banking sector, some stakeholders raised concerns about the more severe prudential treatment of specialised lending envisaged by the Basel Committee in its consultation paper of December 2015 on the revision of the standardised approach. According to these submissions, the consultation paper wrongly assumes that, when compared to corporate lending, specialised lending is a riskier activity. Respondents argued that historical data and recovery rates show that this is not the case. These stakeholders asked for the introduction in the standardised approach of a more risk-sensitive treatment compared to the current one (specialised lending exposures are treated as corporate loans). As regards insurance, assessment is under way on how to revise the capital charges for infrastructure corporates. The Commission services are currently assessing EIOPA's advice, delivered in June 2016, with a view to adopting a further amendment to Solvency II in 2017 to reduce capital charges for investments in infrastructure corporates. Similarly, in the CRR2 package, the Commission proposes to lower credit risk capital requirements for banks' investments in infrastructure which fulfil a set of criteria able to reduce significantly their risk profile. Capital requirements for credit risk on exposures to entities that operate or finance physical assets that provide or support essential public services would be multiplied by the factor 0.75 provided they comply with the criteria mentioned above. C) Accounting rules Stakeholders highlighted the importance of the accounting framework in determining incentives for long-term investment. Specific concerns were raised about the IFRS dealing with the treatment of financial assets (IFRS 9 "financial assets"). This standard is still to be implemented at EU level. As regards the impact on long-term investment, a few stakeholders criticised the ban on the recognition of capital gains and losses in the profit and loss account on the disposal of equity investments. They argued that financial statements will not depict the resulting performance properly, affecting investments in equity. Several respondents addressed the impact of fair value accounting, arguing that it has a potential to exacerbate the effects of economic cycles and increases pro-cyclicality. Respondents from the insurance industry also argued that it is essential that IFRS appropriately reflect the activities of insurers in their financial statements, including the provision of long-term guarantees and long-term investment. In this regard, they raised particular concerns about the interaction between IFRS 9 "financial assets" and the future insurance contract standards (IFRS 17). The latter is being finalised (expected early 2017, with application date in 2020 or 2021) by the International Accounting Standards Board (IASB) and will have to go through the EU endorsement process before becoming EU law. Insurance representatives argue that there is a need for an option to defer the implementation of IFRS 9, so it can be implemented at the same time as the future IFRS 17. Also, IFRS 17 needs to be finalised in a way that works appropriately with IFRS 9 to avoid adverse effects on insurers' long-term activities. As regards the impact of IFRS 9 on long-term investment, the Commission services' analysis in the context of the endorsement process of this standard found that significant changes in the investment strategy of insurers are not expected as a result of this accounting change. However, the Commission services will closely monitor its impact in this area to ensure there are no adverse unintended effects on long-term investments. In the area of banking, see section 5.1.C. As regards the interaction between IFRS9 and the future insurance contracts standard, a solution to the misalignment of the application dates of IFRS 9 and the upcoming insurance standard has recently been finalised by the IASB. The Commission services are currently considering whether the IASB solution is satisfactory for Europe. D) European venture capital funds (EuVECA) and European social entrepreneurship funds (EuSEF) Regulations The analysis of the responses suggests that there is widespread support for broadening the range of managers permitted to manage and market funds using the "EuVECA" and "EuSEF" labels by including managers authorised under the Alternative Investment Fund Managers Directive (AIFMD). Stakeholders also expressed mixed views over reducing the minimum investment required to invest in EuVECA and EuSEF funds by non-professional investors (€100,000). Some respondents were in favour of reducing it, thereby broadening the range of potential investors in order to increase choice for non-professional investors. Other respondents considered the risk profile, contractual obligations and illiquid nature of investing in venture capital and social enterprises to not necessarily be suitable for retail investors with less capital. Others noted that additional tailored investor protection rules would be necessary to support this group of investors, the cost of which would not offset potential increases in the investor base. Moreover, the majority of responses supported an expansion of the range of assets eligible for investment by EuVECA funds, arguing that the definition of qualifying portfolio undertakings is too restrictive. Finally, responses also suggested increasing the limit on employee numbers and removing the turnover and balance sheet limits.

On 14 July the Commission adopted a proposal to revise existing rules on EuVECA and EuSEF funds. The proposal would open up the market for these funds to AIFMD-authorised managers, so that they can offer a full range of products to clients from their home and other Member States, which in turn would increase the overall penetration of such funds. The proposal would maintain the entry ticket of €100,000 for the minimum investment in EuVECA and EuSEF funds. It would permit EuVECA investments in undertakings with up to 499 employees (small mid-caps) and in small and medium-sized enterprises listed on a SME growth market as defined in Markets in Financial Instruments Directive (MiFID II) . It would also permit follow-on investments in a given undertaking that, after the first investment, does not meet the definition of the qualifying portfolio undertaking any more. Moreover, the proposal would decrease costs by explicitly prohibiting fees imposed by competent authorities of host Member States, simplifying registration processes and determining the minimum capital to become manager. E) Tax barriers to cross-border investment Stakeholders highlighted burdensome withholding tax procedures as a major barrier to cross-border investment. Double taxation agreements concluded between states should normally allow investors directly or indirectly investing (among others) through investment funds to avoid double taxation, either by getting relief at source or by benefiting from full or partial refund. However, relief or recovery of withholding tax is, in practice, difficult notably because of the complexity of the procedures, which are also costly and require time to reclaim funds. The non-standardised nature of withholding tax procedures may also require the need to hire local entities to reclaim the funds. Investment and pension funds claimed to be particularly impacted by complex withholding tax procedures. In line with the CMU Action Plan, the Commission services started an exchange of best practices among Member States to make withholding tax procedures more efficient. Work is ongoing with Member States towards agreeing on a code of conduct in 2017 to encourage relief at source when possible and make procedures to reclaim withholding tax more efficient. 2.4.Market liquidity and trading Some industry responses argued that specific pieces of legislation and their cumulative impact have had a detrimental impact on market liquidity, particularly in corporate bond and repo markets. However, other respondents question whether regulation was the main driver, arguing that other factors play a greater role and that the rules are overall beneficial for stability and growth. All agree on the need to gather more data and deepen the understanding of recent liquidity dynamics. Market participants warned that regulation reduces banks' willingness and ability to act as market makers and to transact in repo markets, pointing to the impact of specific (existing and upcoming) rules and the cumulative effect of banking and capital market regulation. A) Impact of banking rules As regards the impact of existing banking rules, stakeholders claimed that higher capital requirements under the CRR/CRDIV have made it more capital-intensive for banks to hold inventory of certain securities and trading assets and that the liquidity coverage ratio (LCR) increases banks' demand for high quality liquid assets (HQLA). However, the main concerns related to upcoming banking rules, where work is ongoing at international level at the BCBS. Some of these overlap with the concerns presented in section 2.1 to banks' ability to finance the economy (e.g. impact of the NSFR). Nevertheless, two specific concerns regarding the impact on market liquidity in particular were also expressed. Leverage Ratio (LR). Respondents argue that the LR is constraining broker dealers’ balance sheets particularly with respect to low margin business, such as repos, and incentivises market-makers to hold fewer inventories on their balance sheets. A preliminary investigation by the European Systemic Risk Board (ESRB) into the potential impact of a LR requirement on market liquidity, found that aside from any costs due to the potential adjustment actions, the LR is also expected to support market liquidity, particularly during periods of stress because it makes firms better able to absorb shocks. The ESRB also investigated the impact of the LR on inventories, trading assets and repo activity from the date of the BCBS announcement in 2010 until end-2014. The findings suggest that banks that needed to improve their leverage ratios to meet a 3% requirement or market expectation have been doing so in part by reducing the size of their balance sheets. However, neither trading assets nor repos have significantly fallen as a share of these banks’ total assets since 2010. Furthermore, the preliminary statistical analysis investigating the relationship between dealers’ inventories and their LR showed very little evidence of a significant relationship between the two since the start of the data series in 2014. Fundamental Review of the Trading Book (FRTB). Under the revised BCBS framework, capital will be calculated for trading activities at a desk level. The framework will also include liquidity horizons for trading risks, requiring more capital for less liquid products. Some stakeholders expressed the concern that the rules might significantly increase the total risk-based capital requirements. Illiquid markets (e.g. corporate bonds) are likely to be impacted more than liquid ones. In the CRR2 package the Commission proposes adjustment to the BCBS proposal on the leverage ratio (see section 2.1.A) and the FRTB. As regards the latter, the FRTB will be phased-in so as to avoid potential disruptions of certain banking services, such as market-making, due to a steep and sudden increase in the overall market risk capital requirements of EU banks. B) Impact of capital market regulation Short-Selling Regulation (SSR). Stakeholders argue that the scope of the exemption for market-making activities for uncovered short sales of shares, sovereign debt securities and sovereign CDS is too narrow. Because of the way market-making activities are defined in the SSR, the exemption can be read as only granted in relation to a financial instrument that is traded on an EU trading venue where the market maker is a member. This would mean that market-making activities on instruments that are not admitted to trading or traded on any trading venue cannot qualify for the exemption since the membership requirement cannot be met. Stakeholders disagree with this interpretation of the notion of "market-making activities" and consider the membership requirement as being excessively restrictive. MiFID II and Markets in Financial Instruments Regulation, MiFID/R (application from 3/1/2018). Market operators and investment firms express concerns that the scope of the pre-trade transparency regime makes it harder to hedge the risk of the position and allows other traders to benefit by taking counter positions in the interdealer market. To compensate for the risk of adverse price movements, the spread may rise (or in some extreme cases dealers may not quote at all). Central Securities Depositories Regulation, CSDR (applicable 2 years after the entry into force of the relevant technical standards). The CSDR aims to reduce the number of settlement fails through a range of measures including – as a last resort – a mandatory buy-in (i.e. an obligatory execution of the initial trade within a certain number of days from the date of the trade) and cash penalties on the party that fails to deliver the securities ('settlement discipline' measures). Together, these measures should discourage settlement fails, leading to a more efficient and reliable settlement. Nevertheless, several issues were raised: First, dealers claim that the introduction of the mandatory buy-in regime may have a negative impact on market liquidity. Second, respondents argued for flexibility in the application of buy-ins, in particular with respect to less liquid assets and assets traded on SME-growth markets. Third, it was argued that the buy-in should be undertaken at the trading level rather than at the CSD level.

Finally, stakeholders argued for sufficient time to prepare for the application of the rules on settlement discipline. Concerns about the level of liquidity are important, but there is a need to understand better the specific impact of regulation on the market and, importantly, to identify any unintended effects. Under the CMU Action Plan, the Commission services are reviewing the functioning of the corporate bond markets in the EU. To feed into this process, a study has been launched on the drivers of corporate bond market liquidity and an expert group of market experts has been established. Further analysis of repo markets is also warranted, given their central importance for market liquidity and banks' liquidity management. Alongside the comprehensive review of corporate bond markets as part of the CMU Action Plan, the Commission services will also assess the functioning of markets in repurchase agreements. With regards to the exemption for market-making activities, the Commission services plan to evaluate the definition of the market making activity in the SSR. Measures supportive of market liquidity have already been introduced in the other areas: - The revised MiFIR RTS 2 introduced a more cautious pre-trade transparency regime via a phase-in regime for non-equity instruments. This ensures that only the most liquid instruments are covered by the scope of the pre-trade transparency requirements. Specific concerns on the pre-trade transparency requirements for package transactions have also been addressed via an amendment of MiFIR (as part of the amendment relating to the extension of the application date). - The majority of the concerns raised on CSDR settlement discipline requirements have been taken into account. The CSDR delegated act on cash penalties and the draft RTS on settlement discipline are carefully calibrated by introducing more proportionate rules for less liquid instruments as well as instruments traded on SME growth markets (e.g. lower penalties for settlement fails and longer periods before buy-ins are launched). Moreover, European Securities and Markets Authority's (ESMA) draft RTS provides for the buy-in taking place at the trading level as unanimously requested by industry. Finally, ESMA's draft RTS proposal and the Commission's delegated act on the parameters for the calculation of cash penalties include a two-year phase-in to provide industry with sufficient time to adapt. 2.5.Access to clearing Many respondents voiced concerns about possible inconsistencies arising from the interaction of market infrastructure (European Market Infrastructure Regulation, EMIR) and predominantly banking legislation (CRR) but also fund management legislation. There are three inter-related strands to these concerns. A) Ability of banks to provide clearing services EMIR requires that liquid and standardised OTC derivatives are centrally cleared through an authorised CCP. Access to CCPs is possible through a clearing member, which in most cases is a large dealer bank. Many respondents noted that small financial counterparties with limited derivatives activity often find it difficult to access clearing. The respondents also argued that the leverage ratio would be penalising for banks acting as clearing members, as their exposures (in the numerator of the ratio) do not take into consideration the risk-reducing effect of (segregated) initial margins (see section 2.1). As a result, this may disincentive banks to continue acting as a clearing member or providing client clearing services, possibly leading to further concentration in CCP membership, higher costs and reduced access to client clearing. Another obstacle noted by respondents was the uncertainty as regards segregation and portability options, and their implications for both clearing members and their clients. Respondents pointed out certain challenges in applying these requirements, which might be difficult to implement in certain Member States due to domestic insolvency laws. The Commission services will consider these points as part of the forthcoming review of EMIR in 2017, in the framework of REFIT, which will be accompanied by an impact assessment which will consider the various issues at stake in more depth. Regarding the LR, the BCBS agreed that initial margin cannot offset the potential future exposure of derivative exposures that a bank centrally clears on a client’s behalf. In the CRR2 package, the Commission proposes an adjusted LR to ensure clearing is not unduly penalised (see also section 2.1.A). B) Margin payments A related problem is that of access to cash collateral for margining purposes. EMIR requires the exchange of collateral for both centrally and bilaterally cleared derivatives transactions. CCPs generally require variation margin to be paid in cash. Pension funds are currently exempt from clearing under EMIR, based on the assumption that they hold little cash and could have difficulties accessing cash collateral in the repo markets in the required volumes. This exemption is set to expire on 16 August 2017, but can be prolonged for an additional year. Once the current clearing exemption expires, pension funds argued that they would be faced with either having to: (i) rely on repo markets for collateral transformation, which may not provide a robust solution in times of market stress; and/or (ii) increase their cash holdings relative to their non-cash asset holdings. As mentioned in section 2.1, respondents argued that the proposed new CRR measures (LR, NSFR) would discourage banks from providing repo services at a reasonable cost. Moreover, respondents argued that for bilaterally cleared contracts, banks increasingly require pension funds to post variation margin in cash, in anticipation of the forthcoming LR and NSFR, where non-cash variation margin received is not recognised as reducing the exposure. As a result, pension funds argued that they would have to hold significantly higher amounts of cash, which can have a negative impact on their returns and can increase even more the demand for cash on markets. The prudential measures proposed in the CRR2 package stem from international standards being developed by the Basel Committee. The Basel Committee has just concluded consultations on possible revisions to the Basel III leverage framework, which included questions related to e.g. introducing an adjusted version of the standardised approach on counterparty credit risk (SA-CCR) to determine the exposure value of derivatives under the leverage ratio, instead of the current exposure method (CEM). The BCBS is not considering allowing non-cash variation margins for the calculations of the LR exposure and, as aconsequence, for the calculation of the NSFR. Given the importance of the issue, the Commission proposes to allow the recognition of Level 1 HQLA received as variation margins to reduce the derivative exposure for the calculation of the NSFR in the adopted CRR2 package. Moreover, the Commission services will, in the context of the EMIR Review in 2017 and following-on from the EMIR Report, assess the relevant technical standards linked to EMIR. Specifically, the Commission services will assess the requirements for pension funds in particular in view of their difficulties in meeting CCP cash collateral requirements (see also "proportionality in derivatives markets", section 3.2). Moreover, the Commission services will consider whether or how corporates and small financials should be captured by clearing and margining requirements. C) UCITS restrictions focusing on OTC derivatives Respondents argued that the application of several restrictions set out in the Directive on Undertakings for Collective Investment in Transferable Securities (UCITS) to centrally cleared OTC derivatives is at odds with EMIR's policy objectives on central clearing. They claim that the statutory counterparty exposure limits (5% or 10%) constrains UCITS' ability to invest in cleared OTC derivatives. Stakeholders questioned whether those diversification limits are still appropriate, given the EMIR central clearing obligation. Furthermore, stakeholders claimed that UCITS cannot use the cash proceeds from a repo transaction to post margins for cleared OTC derivatives transactions. This restriction derives from ESMA's Guidelines on ETFs and other UCITS issues which prohibit any reuse of cash by the UCITS fund. The Commission services have requested ESMA to analyse the evidence submitted on UCITS restrictions as regards the use of OTC derivatives. Any potential follow-up will be part of the UCITS review.





3.Enhancing proportionality of rules without compromising prudential objectives Proportionality is at the centre of the Commission’s Better Regulation agenda. Regulation must be applied in a proportionate manner to regulated entities, reflecting their business model, size, systemic significance, as well as their complexity and cross-border activity. More proportionate rules will help promote competition and enhance the resilience of the financial system by safeguarding its diversity and dynamism without compromising prudential objectives. Lower entry barriers will allow new players to substitute for services lost when less resilient firms exit the market. At the same time, care must be taken to ensure that measures aimed at enhancing proportionality do not distort the level playing field. Respondents raised the issue of proportionality of legislation in several areas, including in particular banking (section 3.1), derivative markets (section 3.2), insurance (section 3.3), fund management and credit rating agencies (section 3.4). 3.1.Proportionality in banking rules The concept of proportionality is clearly recognised in the CRR, and differentiation is already reflected in many rules (e.g. exemption on calculating market risk requirements for banks with small trading books). The framework as a whole is formulated in a modular manner, such that institutions must only apply those requirements which are relevant to the risks they incur. Furthermore, the framework provides for specific exemptions and preferential treatments for various purposes (e.g. own funds, liquidity, covered bonds), thus reflecting the relative complexity and riskiness of institutions and the activities they undertake. Nevertheless, a large number of respondents called for a more proportionate application of banking rules arguing that these do not sufficiently differentiate between the very large systemic institutions and very small local institutions. Some stakeholders, whilst seeing problems in specific requirements, argued against potential changes, as this would require putting in place new systems, thereby imposing additional costs on companies or because it would create an un-level playing field between institutions that compete with each other in the same markets. Respondents questioned the proportionality principle with regards to: Prudential, reporting and disclosure requirements Remuneration Investment firms Bail-in requirements CCPs holding banking licences A) Prudential, reporting and disclosure requirements On reporting and disclosure requirements, respondents highlighted the difficulty for smaller and less complex banks to comply with them. There were further concerns that EU reporting requirements were topped-up by supervisors with additional recurrent reporting requirements. Stakeholders argued that banks of less complexity and/or smaller balance sheet size usually pose less of a risk to the economy, and that supervisors should seek to obtain the information they need without enforcing a disproportionate cost on such institutions. They also argued that such banks should be subject to lighter prudential requirements. However, other respondents, while acknowledging the principle of proportionality, argued that the principle needs to be applied with care and that it should relate to bank riskiness (rather than size). They put forward the case that relaxing requirements for some institutions would be more appropriate in relation to only reporting and disclosure requirements as opposed to also including the actual prudential requirements. In the CRR2 package, the Commission proposes to address concerns related to disproportionate compliance and administrative burden for smaller banks as follows: - by mandating EBA to develop tailored reporting requirements involving less frequent and less detailed reporting; - by amending the CRR to provide for differentiated disclosure requirements involving less frequent and less detailed disclosure; - by mandating EBA to develop an IT tool that would help small banks to distinguish the rules which are relevant to their size and activities from those rules which should apply only to larger and more complex banks. The Commission also proposes to further tailor prudential requirements in selected areas. This is for example the case for: - the trading book (e.g. extension of the de-minimis threshold and keeping the current standardised approach for calculating market risk for certain types of banks);

- counterparty credit risk (e.g. keeping the original exposure method for certain types of banks); - the leverage ratio (lower leverage ratio or partial exclusion of the leverage ratio for certain business models or activities such as promotional banks); - the NSFR (e.g. preferential treatment of certain activities such as trade finance, CCPs, promotional loans, etc.). Tailored requirements take into account a variety of metrics, which includes size or type of activity. B) Remuneration The CRR/CRD contain a number of requirements regarding the remuneration policies and practices of credit institutions and investment firms. These requirements were introduced in the aftermath of the 2008 financial crisis to ensure that remuneration policies do not encourage excessive risk-taking behaviour which was one of the contributing factors to the crisis. Remuneration practices in the financial services industry meant that those incentives were not in line with the long-term objectives of firms and the need for responsible risk-taking. The first remuneration rules, adopted in 2010, were further extended, mainly with the 'maximum ratio rule' between variable and fixed remuneration, following the adoption of CRD IV in 2013 (with the new rules applicable as of 2014). Numerous responses suggested that a more proportionate approach (i.e. allowing some exemptions) should be reflected in the application of these remuneration rules, especially concerning deferral and pay-out in instruments (applicable since 2011). Arguments have been advanced that these requirements entail compliance costs that tend to outweigh their prudential benefits in case of smaller and non-complex firms or staff with relatively low levels of variable remuneration. Finally, concerns have been raised that the maximum ratio rule would reduce institutions’ competitiveness, inter alia by negatively affecting their ability to attract and retain talented staff in comparison with non-regulated firms (either within the financial industry sector or in other sectors to which skills are transferable). The Commission carried out a consultation on the impact of the maximum remuneration ratio and the overall efficiency of CRD IV remuneration rules: a feedback report was issued in July 2016 summarising the responses. The responses to that consultation and to the call for evidence, together with input from EBA and from an external study, have been taken into account in the Commission’s review of the CRD IV remuneration rules, reflected in the Commission report COM(2016) 510 of 28 July 2016. Following-up on the conclusions of this report, the Commission proposes in the CRR2 package to exempt small and non-complex institutions and staff with low levels of variable remuneration from the deferral and pay-out in instruments remuneration requirements. Regarding the maximum ratio, the Commission report found that for the time being there is insufficient evidence to draw final conclusions on the impact of the rule, which has been in force only since 2014. C) Investment firms Investment firms argued that the application of some rules under CRR/ CRD IV are disproportionate if they are not tailored to their business models. In particular, it was argued that the CRR/CRDIV should better distinguish between the capital requirements imposed on large, bank-like investment firms and those imposed on smaller investment firms. As announced in the Commission Work Programme 2017, the Commission services will carry out an evaluation of the CRR treatment of investment firms, in the framework of REFIT. This exercise will take into account the EBA advice and discussion paper delivered in October 2016 where it is recommended that only those investment firms that are currently identified as Other Systemically Important Institutions (OSIIs) or Globally Systemically Important Institutions (GSIIs) remain subject to the full CRR/CRDIV regime while a more proportionate regime could be developed for firms which are not in this category. As an interim proportionality measure, the Commission proposes to "freeze" requirements in the CRR2 package for non systemic investment firms: this will allow the majority of investment firms to remain on the CRD IV rules until the investment firm review is completed, thereby reducing the regulatory burden on these firms. D) Bail-in requirements Banks questioned the proportionality of minimum requirements for own funds and eligible liabilities (MREL) under the BRRD, in particular as regards certain bank business models. Often these claims were referring to the total amount of total liabilities minimum MREL requirement included in the draft EBA RTS. Deposit-funded retail and commercial banks that do not rely on wholesale funding claimed they would have to raise additional wholesale funds, which would have to be reinvested. This could mean an artificial expansion of these bank´s balance sheet and consequently increase of leverage and deterioration of their risk profile. This could have an influence on the riskiness of assets and profitability. In case the investor base in the local market would be missing, these banks could be forced to raise funding abroad in foreign currencies, which would bring foreign exchange risk. Respondents also raised concerns about inconsistencies between MREL and total loss absorbing capacity (TLAC) measures. In the delegated act, the EBA RTS has been amended by the Commission to address inconsistencies between the RTS and the BRRD. Residual concerns have been addressed in the TLAC/MREL proposal which recommends to implement TLAC for G-SIBs only and maintain the case-by-case setting of MREL for other banks. Furthermore, the proposal is also to modify the BRRD in order to promote the technical consistency between the TLAC and the MREL framework. E) CCPs holding banking licences A few respondents argued that the BRRD is inappropriately calibrated or applied to CCPs that hold banking licences. Moreover, they argued that the resolution (winding down) of CCPs is already partially covered by EMIR and level 2 texts (via a default waterfall including a default fund and a loss-sharing mechanism) and that standard business relations of financial market infrastructures do not lead to "bailinable" liabilities. Finally, it was argued that if deposits placed with such institutions were made subject to potential bail-in, settlement efficiency would decline substantially and participants would rather use pre-financing by the financial market infrastructure. The Commission proposes to amend the BRRD as to ensure that CCPs with banking licenses currently subject to the BRRD will be carved out from its scope and brought exclusively under that of the proposed CCP Recovery and Resolution Regulation. 3.2.Proportionality in derivatives markets Some respondents argued that the impact of EMIR on non-financial corporations (NFCs) is disproportionate. Respondents noted that NFCs face significant challenges in meeting EMIR requirements due to limited resources and experience, especially as regards the reporting requirements. For example, NFCs may be finding the hedging exemption difficult to monitor and apply in practice, which could result in inconsistent regulatory treatment of NFCs across the EU. Many respondents questioned whether such counterparties pose systemic risk to a degree that justifies continued application of EMIR requirements. In addition to NFCs, several respondents suggested that certain small financial counterparties (such as small pension funds, small investment funds, small insurers and small banks) undertake such limited OTC derivatives activity that it is not commercially viable for them to establish clearing solutions.

As part of the EMIR review scheduled in 2017 and as set out in the EMIR Report, the Commission services will consider adjustments to the scope of EMIR clearing and margin requirements in order to address the diverse challenges faced by NFCs, small financials and pension funds. In particular with respect to pension funds, the EMIR review will consider whether to extend the current temporary exemption from the EMIR clearing obligation or whether to make this exemption permanent. 3.3.Proportionality in insurance Solvency II replaced 28 national regimes by a single risk based framework. According to Article 29(4) of the Solvency II Directive, the delegated acts and the regulatory and implementing technical standards adopted by the Commission shall take into account the principle of proportionality, thus ensuring the proportionate application of this Directive, in particular in relation to small insurance undertakings. Even though Commission Delegated Regulation (EU) 2015/35 sets out numerous provisions on proportionality, stakeholders complained that the application of the proportionality principle is impaired in practice, resulting in excessive and disproportionate burden on small and medium-sized insurers. However, it was also underlined that, given its recent entry into force, the true impact and application of the principle of proportionality can only be judged once Solvency II has had a chance to “bed down”. For example, under Solvency II, small insurers can benefit from lighter reporting requirements (waivers of quarterly reporting or item-by-item reporting are possible). However, these reliefs are subject to the discretion of the supervisory authorities (and hence vary in different jurisdictions). The implementation of these options is currently being monitored by EIOPA which is expected to report on this by the end of 2016 (see also section 4.1.C). Stakeholders also underlined in their responses that Solvency II is a highly complex system consisting of numerous provisions which are specified in several regulatory levels (the set of Solvency II rules amounts to over 6,500 pages, most of which are guidelines and supervisory material issued by EIOPA). As a consequence, it was argued that it is very onerous for small and medium-sized insurance companies to keep track of all requirements and their interdependencies. In addition, stakeholders argued that the excessively restrictive guidelines and interpretations of the provisions allowing for proportionate flexibility limit the principles-based approach of the Directive. Finally, stakeholders also raised concerns about the cost of contracts insurers are obliged to have with credit rating agencies, given that the standard formula calculation contains multiple references to the ratings provided by External Credit Assessment Institutions (ECAI). In specific situations, in particular scenarios involving small and medium undertakings, this information would only be collected for the purposes of reporting, which would carry a non-proportional burden for those undertakings. The Commission services believe that further work should be done to ensure that all requirements are proportionate to risks. As a first step, on 18 July 2016 the Commission issued a call for advice to EIOPA on the review of 17 specific items in the Solvency II Delegated Regulation. Among other things, EIOPA is tasked to work on simplified methods, assumptions and calculations of certain modules in the standard formula and to further develop the framework for the use of alternative credit assessments. The technical advice will feed into the review of the Solvency II Delegated Act where these issues are intended to be addressed. 3.4.Proportionality in other sectors A) Asset management Many asset managers raised concerns about the proportionality and compatibility of different remuneration requirements across legislation. Many management companies offer services and products that fall within the scope of different pieces of legislation, in particular the UCITS Directive, AIFMD and MiFID. As a result, they are legally required to comply with three different sets of rules with regard to remuneration of their personnel. Stakeholders claimed that applying all these rules within one employment contract is barely possible. In addition to the submissions on remuneration, many industry respondents argued that the scope of the AIFMD is too broad. The definition of “alternative investment fund” currently captures essentially all collective investment vehicles which are not authorised as a UCITS. Stakeholders suggested that the rules should take into account the differences between the various collective investment schemes in order to preserve the diversity of financial products offered. ESMA has already issued guidelines on remuneration policies under the UCITS and AIFM Directive. Building on the approach set out in the CRR2 package, the Commission will assess the proportionality of rules in the Alternative Investment Fund Managers Directive (AIFMD) and the Undertakings for Collective Investment in Transferable Securities Directive (UCITS), for example in relation to aligning remuneration regimes and reducing reporting burdens. B) Credit rating agencies (CRAs) In addition to concerns about the lack of competition in the credit rating market (see also section 4.4.A), respondents also argued that the implementation of the EU regulatory framework for credit rating agencies leads to a disproportionate cost for smaller CRAs while larger CRAs seem to be able to more easily absorb the incremental expenditures. They also claimed that the limits for exemptions are set too low as CRAs with more than 50 employees have to cope with all the requirements of the CRA Regulation. Even though they welcome the CRA III Regulation as a significant step to rebuild market confidence in the quality of rating agency work, in their view the multiple layers of compliance and governance costs primarily hinder smaller CRAs from developing their business in Europe without offering tangible benefits from the mandatory registration regime. On this basis, respondents called for a more proportionate approach to the implementation of the rules. Respondents also suggested that the same governance structure should not be required in each office, but certain governance functions could serve across legal entities in Europe. Based on its mandate in the CRA Regulation, the Commission adopted a report in October 2016 on the state of the CRA market. The report confirmed that overall a balance has to be found between the proportionality of the standards that should apply to smaller CRAs and the necessity to ensure the quality and transparency of the ratings they produce. Hence the Commission will continue to monitor the application of the CRA Regulation on smaller CRAs, in particular the issue of proportionality. This includes simplifying reporting requirements in order to reduce compliance costs or clarifying certain existing exemptions for companies up to a certain threshold in terms of turnover or number of employees and other proportionality measures.



4.Reducing undue regulatory burden The regulatory reforms have introduced a large number of new, sometimes complex rules in order to make the financial sector stronger and more resilient. This has posed additional administrative burdens and costs on firms. While sound regulation of the financial sector is necessary to achieve the policy objectives of preserving market integrity and ensuring financial stability, it is important to make sure that the regulatory burden is commensurate with the intended objectives. In line with the Commission's Better Regulation approach, there is a case for assessing and designing rules in such a way that they achieve their objectives at the lowest possible cost, not just for financial services providers but ultimately for the end-users of financial services. In particular, stakeholders argued for a need to further streamline, to the extent possible, the existing supervisory reporting and public disclosure requirements which are often perceived as being inconsistent and/or duplicative across legislation, excessively complex and not always fit for purpose (see sections 4.1 and 4.2). On top of specific sectorial follow-up actions, there is also a need for a more comprehensive Fitness check of reporting requirements. This is the reason why a project on Financial Data Standardisation (FDS) was launched in order to assess the potential to report financial data more efficiently (at lower cost) and produce better data for risk assessment by the supervision authorities (more details can be found in the dedicated box at the end of section 4.1).

Beyond reporting and disclosure requirements, the scale and pace of regulatory change in recent years have been a key source of compliance costs. The complexity of EU rules, the interaction between various layers of regulation, the inconsistencies of certain rules and the poorly aligned, tight timelines for implementation are seen as challenging in terms of compliance burden on regulated firms. Significant compliance costs also result from divergent transposition of EU Directives into national legislation and from inconsistent enforcement of EU rules. Moreover, many respondents pointed to national rules or supervisory practices “gold-plating” EU rules, thus leading to additional and/or overlapping requirements which are seen as unduly burdensome and can create barriers to the cross-border activity of financial firms (see section 4.3). Finally, it is important to make sure that regulation does not create any undue barriers to entry in national markets and across borders. There is a need to ensure that EU law is correctly implemented and enforced in all Member States, that national rules do not create unnecessary burdens or obstacles to the provisions of financial services within the single market, and that there is international coordination to avoid an un-level playing field in global markets (see section 4.4). 4.1Supervisory reporting requirements A) General issues The reforms introduced new and/or more stringent supervisory reporting requirements with the aim of ensuring better financial supervision at both micro and macro level. Supervisory reporting should allow supervisors to monitor the safety and soundness of financial institutions as well as the safety of the financial system as a whole, to ensure compliance with investor/consumer protection rules and to detect abuses that undermine market integrity. Although the rationale of the reporting requirements set out in EU law is valid, respondents from the financial industry pointed to a number of inconsistencies and duplications, and to some unduly burdensome requirements. In some cases, overlaps and/or divergences in the data to be reported to supervisors can be explained by the different objectives of such reporting (e.g. MiFIR reporting is aimed at enabling national competent authorities (NCAs) to monitor market abuse, while EMIR reporting aims at introducing greater transparency into the OTC derivatives markets for regulators to monitor and for market participants to see market trends). However, notwithstanding the different policy objectives, there are instances where requirements can be streamlined or adjusted. In particular, there is scope for further standardising reporting and reducing the administrative burden. This should go hand in hand with increasing the quality of data provided to supervisors and disclosed to the public as well as maintaining high standards of consumer protection rules. Such changes do not necessarily imply a major overhaul of existing reporting requirements. At least in the short term, such changes would risk further increasing compliance costs instead of reducing them. Although the new reporting requirements have generated additional compliance costs for firms, these are often one-off costs that the industry has already incurred, and any adjustments would trigger new costs. A general concern is the lack of sufficiently aligned formats, standardised templates, and common IT solutions, which may result in excessive complexity and errors. The lack of a central data collection point for the varying reporting requirements was also raised as a source of unnecessary complexity, for example in the case of AIFMD. Stakeholders argue that the lack of coordination among NCAs, and between NCAs and the European Central Bank (ECB), generates inconsistent and burdensome requirements (e.g. the additional liquidity monitoring metrics where the SSM requested data, while the EBA was still consulting NCAs). Furthermore, banks argue that the Commission implementing regulation on supervisory reporting requires banks to report financial information ("FINREP") which overlaps with other national reporting requirements. A mapping of those national requirements which go beyond those imposed at EU level could be useful and prepare a discussion with Member States of possible ways to address the identified issues. Also, monitoring national supervisory practices, in cooperation with the European Supervisory Authorities (ESAs), could be useful in order to identify the additional reporting requirements imposed in practice by supervisors on top of EU law, including those which may not be justified. In the banking sector, respondents are also concerned about the immediate impact of the new European Reporting Framework which is being developed by the ECB/SSM. However, they admit that it will be advantageous once completed, since its ultimate goal is for data to be collected once and for duplicative requirements to be avoided. The Commission will undertake a comprehensive review of reporting requirements in the financial sector, in the framework of REFIT. Morevover the financial data standardisation project (see the dedicated box at the end of section 4.1), supported by the ISA2 programme, aims to develop a common language on financial data that will address the compliance burden at source and prepare the ground for a ‘once for all’ approach to reporting. With regards to requirements stemming from national laws and supervisory practices: - The Commission assesses systematically the correct implementation of all financial services Directives and where relevant also of Regulations. If it identifies national reporting requirements gold-plating EU rules which are incompatible with EU law, it will challenge them via infringement proceedings if the problem is not resolved swiftly. - Besides the assessment of national transposition measures in terms of compliance with EU law, a process for mapping national requirements that go beyond those imposed at EU level could be envisaged over time, in view of discussing with Member States possible ways to address the issues identified and sharing best practices, including through potentially more common IT solutions. This could be done in the existing Expert Group on barriers to the free movement of capital or in other specialised expert groups. Moreover, the Commission services will examine the case for establishing central data collection points. Specifically in relation to concerns raised regarding the AIFMD, the Commission services will consider with ESMA the stakeholder proposal to establish a central data collection point within ESMA for the varying reporting requirements under the AIFMD, which could help ensure the use of a single format with corresponding data requirements and relieve the necessity for NCAs to collect this data and pass it on to ESMA. B) Duplicative and/or inconsistent reporting requirements Stakeholders provided some examples of requirements set out in EU legislation that are perceived as duplicative and/or inconsistent across pieces of legislation:

EMIR, MiFIR, Securities Financing Transactions Regulation (SFTR), Regulation on wholesale energy market integrity and transparency (REMIT), UCITS and AIFMD require some data to be reported that is similar but with differences in terms of reporting details, reporting channels, data repositories’ requirements and processes, and applicable IT standards. Overlaps are in part due to the different objectives of each set of reporting. MiFIR and SSR have different reporting requirements for short sales due to different regulatory objectives. On the one hand, the SSR establishes an obligation to report net short positions on shares and sovereign debt securities to the NCA and/or to the public above certain thresholds. This is to ensure transparency over large aggregated short positions. The objective is to enable regulators (and the market) to monitor systemic risk that an excess of the short selling activity may entail and take action where needed. The obligation lies with the investor and relates to aggregated positions at the close of business. Positions held by market makers are, however, exempt from this reporting requirement. In contrast, Article 26 of MiFIR on the transaction reporting requirement applies – without exception - to all transactions in financial instruments admitted to trading or traded on a trading venue. The MiFIR transaction reporting requirements also apply to all individual transactions and not to the aggregated positions, such as under SSR. It places the reporting obligation on the investment firm executing the transaction, not on the final investor, and there is no exemption for transactions for the market making activities. The MiFIR reporting regime is essentially intended as a monitoring tool to identify market abuse and manipulations that may be sanctioned under MAR. Solvency II and EMIR require insurers to report to both trade repositories and supervisors. Different definitions and reporting deadlines are set out in Solvency II, EMIR, MiFID, MAR (e.g. under EMIR insurers report the "effective date" of a derivative whereas under Solvency II they report the "initial date", which is defined differently). Whilst each reporting requirement has been designed for a somewhat different purpose, the potential for making the reporting more cost efficient and more effective in terms of meeting its objectives will be investigated. The fragmented reporting of net short positions as well as temporary restrictions on short-selling across Member States under SSR was also raised as a concern, with some stakeholders calling for a single reporting platform. With regards to EMIR, the Commission has adopted in October 2016 a RTS on the minimum details of the data to be reported to trade repositories and a ITS with regards to the format and frequency of trade reports to trade repositories. Both are currently under the scrutiny period in the EP and Council. Moreover work is on-going with regards to the data be published and made available by trade repositories and operational standards for aggregating, comparing and accessing the data. Finally, with regards to SSR, the Commission services will assess the possibility of introducing a single reporting platform on short-selling to strengthen the information provided to regulators and examine ways to reduce burdens on the reporting of net short positions. C) Disproportionate and/or excessive reporting requirements According to respondents, some reporting requirements are disproportionate or excessive/difficult to meet, for example: Under Solvency II, insurers have to submit highly granular annual and quarterly information on their risk situation, which may not be necessary for small companies with a simple risk profile. As noted in section 3.3, small insurers can benefit from lighter reporting requirements (waivers of quarterly reporting or item-by-item reporting are possible). It is also argued that the “look-through approach” for reporting investment in funds creates excessive burden for insurers. However, the look-through approach is already applied to a minimal extent to get information necessary for risk management. Only the asset category, the country of issue and the currency of the underlying assets must be reported (no line by line reporting of underlying assets is requested). Quarterly reporting is mandatory only where funds represent more than 30% of total investments. It is seen as difficult for smaller and less complex banks to comply with reporting requirements imposed by the Implementing Acts adopted under the CRR, in particular because of the content and frequency of the reporting. Such reporting requirements may need to be reviewed to ensure proportionate reporting for smaller and less complex banks. Dual-sided reporting to trade repositories under EMIR is seen as unnecessarily burdensome, especially for NFCs and small/non-systemic financial counterparties. MiFID best execution reporting requiremen