Including updates on SME access to finance, consumer protection in insurance and the failure of RBS


Improving SMEs’ access to finance

The financial system is supposed to oil the wheels of the real economy by allocating resources, increasing capital formation, stimulating productivity growth and acting as a repository of national savings. However since 2008 the fragility of Europe’s financial system has been a significant drag on the real economy. Trade associations have pointed to significant difficulties experienced by small and medium sized enterprises (SMEs) in accessing credit since the 2008 crisis. A new survey published by the European Commission shows that 15% of SMEs are concerned about difficulty in accessing finance (although low this is still a top concern for SMEs).

The Commission is keen to help reverse this trend and has released an action plan to help SMEs access more financial resources and help kick-start the sluggish EU economy this month.

The Commission has released legislative proposals to accelerate the growth and cross-border operation of venture capital funds. The regime will apply to venture capital funds below €500 million —above this threshold they would be required to comply with the requirements of the Alternative Investment Fund Managers Directive (AIFMD). However, designation as a European Venture Capital Fund (EVCF) through compliance with uniform requirements (such as in terms of the investment portfolio, investment techniques and eligible undertakings that may be targeted) and associated registration and simplified reporting requirements will provide an EU-wide passport which is hoped will expand the potential investor base.

This proposal is complemented by a second initiative to promote investment in ‘social entrepreneurship funds’ across Europe plus:
  • measures to make more visible SME markets (in MiFID) and SME shares (in the Transparency Directive)
  • reducing the costs and the burden for SMEs (Transparency and Prospectus Directive) by simplifying and reducing reporting requirements. The aim is the increase larger SMEs’ use of capital markets to facilitate growth.
  • accelerating the implementation of the Late Payments Directive in advance of the transposition deadline of March 2013. Late payments are costly for European businesses, amounting to some 1.1 trillion euros in terms of delayed turnover.
A separate regime for SMEs designed to stimulate growth makes a lot of sense in the current economic climate in Europe. However, it does raise questions about the possibility of a conflict of objectives in terms of the treatment of investment funds. AIFMD’s primary objective is to ensure appropriate regulation of all systemic players in the financial markets: these new proposals may create systemic players which will be subject to less stringent requirements as long as there remain below the given threshold. This potentially leaves the door open to gaming. As always, there will be important issues to resolve around the threshold, particularly as transition from one regime to the other will require a step change in requirements. One objective of the proposal on venture capital funds is to permit more economies of scale for funds operating across borders: thus suggesting a growth objective, potentially pushing more operators into the threshold ‘zone’. Therefore, the interaction of the new venture capital regime with AIFMD and other EU Directives will need to be properly calibrated and clarified.


EIOPA highlights consumer protection issues

EIOPA’s Chairman, Gabriel Bernardino has called on the insurance industry to re-evaluate conventional customer protection policy tools, particularly in relation to current market failures such as information asymmetries, conflicts of interest and market inefficiencies in 2012.

At EIOPA’s first Consumer Strategy Day in Frankfurt on 6 December 2011 (which was attended by over 130 participants) three panel discussions were organised to address:
  • fostering protection of policyholders and pension fund beneficiaries
  • tackling new or innovative financial activities
  • anti-discrimination and assessment of risk.
At the event, Bernardino indicated that proposals on Packaged Retail Investment Products (PRIPs) will take centre stage in 2012, focusing on providing comparable information to clients on such products regardless of the sector in which they are produced. These proposals will complement provisions in MiFID II — which address marketing and selling practices — and should be accompanied by an equivalent overhaul of the Insurance Mediation Directive (IMD) in respect of insurance-based PRIPs. However, the Commission has not indicated the release date on the IMD proposal and there are growing concerns that IMD revisions may be insufficient to ensure equal treatment and protection for retail customers across all forms of PRIPs.

At the Consumer Strategy Day, EIOPA announced that there will also be more attention on issues such as financial literacy and education in 2012, in collaboration with EBA and ESMA through the Consumer Protection Sub-Committee to be set up under the Joint Committee. In 2011, EIOPA published a number of reports (including one on 6 December) on financial literacy and education initiatives and is currently finalising its report on insurance-specific consumer trends in the EU.

In the future, EIOPA will increasingly focus on product development and will monitor market activities closely to fulfil its reporting and prohibition role. This will involve on-going communication with national supervisory authorities and other stakeholders. Bernardino envisages that the annual Consumer Strategy Day will be a key plank to this objective providing much needed transparency and certainty on EIOPA’s upcoming work programme for the insurance industry.

Bernardino’s assertion that consumer protection — along with gearing-up for the implementation of Solvency II — will be a top priority for 2012 is not surprising as it was a key work stream for EIOPA this year, with public consultations on variable annuities and complaints-handling published recently. The latter consultation proposed that all insurers should introduce a ‘complaints management policy’ which is set and endorsed by senior management and made available to all relevant staff, with parts of it released to the general public. The policy should outline how complaints are investigated, how information is collected and how it is reported to supervisors.

The variable annuity consultation was limited to analysing good practices related to the disclosure and selling practices for these products, and did not set forth any guidelines or recommendations. In relation to disclosures, the consultation suggests that firms should provide general information on the insurance undertaking and the legal and supervisory regime it operates in, to take account of the cross-border nature of this business. It should also include product specific information to address product complexity. In relation to selling practices, insurers should ensure that variable annuities are always sold on an advised basis, even when they are sold directly by the company. Moreover, firms should focus on the customer’s objectives to determine the relevant customer’s specific demands and needs.

EIOPA has also put out for public consultation its response to call for advice on the review of the Institutions for Occupational Retirement Provision Directive which focuses on the activities and supervision of the institutions for occupational retirement provision. The response envisages that the quality of information to be provided to the pension plan members and beneficiaries should be significantly improved. This includes the creation of a Key Information Document containing the most relevant elements that consumers will need to take informed decisions.


FSA reports on the failure of RBS

The UK’s Financial Services Regulatory Authority (FSA) has published its long-awaited report into the failure of Royal Bank of Scotland (RBS). At 452 pages, it represents a significant body of work charting the rise and fall of one of the world’s largest banks. The report investigates the causes of the failure of RBS in 2008; as well as examining the deficiencies it highlighted in the regulatory framework, supervision and the management of firms. The report also explains why the FSA's Enforcement and Financial Crime Division concluded that there were insufficient grounds to bring enforcement actions against RBS and its management.

The FSA found that multiple elements combined to produce RBS’s failure. It describes the ‘errors of judgement and execution’ made by RBS executives and management during the run-up the crisis, including:
  • an ‘over-reliance’ on risk short-term wholesale funding
  • undertaking inadequate due diligence on the acquisition of ABN AMBRO
  • imprudent lending practices
  • inadequate capital levels.
The report is also highly critical of the FSA’s approach to the supervision of systemically important firms in the pre-crisis period, stating that its ‘overall philosophy and approach was flawed’. Principally, the FSA supervisory process did not put sufficient focus on the core prudential issues of capital and liquidity, and failed to give adequate attention to key business risks and asset quality issues.

The report makes some general proposals on how to prevent a similar crisis in the future, including:
  • Strict liability: senior personnel of failed banks could be held ‘strictly liable’ for the consequences of their bad decisions. Lord Turner, the FSA chairman, acknowledges that a ‘strict liability’ standard ‘may prove impossible’ to implement given the legal complexities associated with this matter.
  • Pay clawbacks: automatic, incentive-based penalties could be imposed on the heads of failed banks as an alternative to imposing strict liability for poor decisions, which are already common place in other banking jurisdictions.
  • Takeover approval: large acquisitions by FSA-regulated firms should be subjected to supervisory approval and only granted if the capital base of a bank is ‘exceptionally strong’. This proposal has attracted widespread support from across the financial industry according to press reports. However, some critics argue whether supervisors are in a better position to make strategic decisions on the firm’s growth strategy than its appointed board.
  • Success fees: the board should take independent advice on large acquisitions from an adviser whose fee is not linked to the successful completion of the deal.
The RBS report has highlighted significant deficiencies in the UK’s banking regulatory and legal environment, and the lessons learnt can probably be applied to many other European countries. While much work has been done by supervisory authorities in the aftermath of the crisis to address these problems, the publication of the report demonstrates the huge costs associated with bank failure — the UK government’s equity stake of 45.5 billion pounds has lost well over half its value since 2008 — and the importance of making the necessary changes to prevent (or a least reduce the probability) of a similar crisis from ever happening again in the future.