The General Board of ESRB held an extraordinary meeting to discuss the first set of actions in five priority areas identified to address the impact of COVID-19 emergency on the financial system, from a macro-prudential perspective. The priority areas are focused on macro-prudential implications of guarantee schemes, liquidity risks arising from margin calls, impact of credit rating downgrades in corporate bonds sector, restrains on dividends and other payouts, and implications of market illiquidity for asset managers and insurers.
These actions are guided by two overarching principles. One principle involves the use of flexibility provided in existing regulatory standards and the other involves achieving an effective policy response across sectors and countries while ensuring that necessary national macro-prudential actions do not cause negative spillovers and effects in the Single Market in EU. The following are the key highlights of the priority areas were discussed at the meeting:
- Macro-prudential implications of guarantee schemes and other fiscal measures. ESRB is undertaking a stock take of the measures implemented so far and is setting up a framework for monitoring the macro-prudential implications of these measures, with focus on the cross-border and EU levels. ESRB strongly encourages cooperation and information exchange between the relevant national fiscal and macro-prudential authorities to help understand the effects the implemented measures have on financial stability. ESRB, in a letter to the Economic and Financial Affairs Council, highlights that work in this area has three main objectives: identifying implications of these measures for financial stability; establishing minimum requirements for monitoring framework that help understand the effects these measures; and outlining future work on cross-border and cross-sectoral effects of these measures and their effect on financial stability. By the end of May 2020, ESRB will review the existing reporting system and define minimum requirements for an EU framework for monitoring the implication of fiscal measures for financial stability.
- Liquidity risks arising from margin calls. The General Board of ESRB discussed two issues related to financial stability issues: high amounts of margin calls since mid-February and possible adverse liquidity impact on both bank and non-bank entities, also in view of high degrees of market concentration and inter-connectedness. The high amounts of margin calls could increase further due to likely forthcoming credit rating downgrades and possible further market volatility. The General Board stressed the importance of mitigating procyclicality that could be linked to the provision of clearing services and to the exchange of margins in bilaterally cleared markets. The Board also stressed on the importance of enhancing central counterparty stress test scenarios for the assessment of liquidity needs and limiting excessive liquidity constraints related to margin collection.
- Impact of procyclical downgrades of bonds on markets and entities across the financial system. The economic disruptions caused by COVID-19 could trigger a wave of credit rating downgrades in the corporate bonds sector due to the systemic increase in credit risk. From the macro-prudential perspective it is important to ensure that the effects of these credit rating downgrades are well understood and do not impair the functioning of financial markets so that the negative effects on the real economy are minimized. ESRB discussed these issues in a note it published. Furthermore, the General Board decided to coordinate a top-down analysis, with ESAs and ECB, to assess the impact of a common scenario of large-scale downgrades across all parts of the financial sector (banks, investment funds, insurers, pension funds, and financial markets).
- System-wide restraints on dividend payments, share buybacks, and other payouts. A number of ESRB member countries and European-level institutions (EBA, ECB, and EIOPA) have encouraged banks and insurers in EU to restrain voluntary payouts, such as dividends, bonuses, and share buybacks, aimed at remunerating shareholders. AT this meeting, the ESRB General Board supported the actions taken so far and stressed the value of applying pay-out restrictions in times of crisis.
- Market illiquidity and implications for asset managers and insurers. Investment funds and insurers with regard to unit-linked insurance products may see further redemption pressures if the macro-economic outlook worsens by more than is currently anticipated. ESRB adopted a recommendation to ESMA to coordinate with the national competent authorities in undertaking a focused piece of supervisory engagement with investment funds that have significant exposures to corporate debt and real estate assets. The objective of the engagement is to assess the current state of preparedness of these two fund segments to potential future redemption pressures, further declines in market liquidity or increased valuation uncertainty, while also considering any steps that could enhance that preparedness.
- Press Release
- Letter on Implications of Guarantee Schemes (PDF)
- ESRB Recommendation to ESMA (PDF)
- Note on Liquidity in Corporate Bond Market (PDF)
Keywords: Europe, EU, Banking, Insurance, Securities, COVID-19, Dividend Distribution, Systemic Risk, Credit Risk, Macro-prudential Policy, Liquidity Risk, ESMA
Sam leads the quantitative research team within the CreditEdge™ research group. In this role, he develops novel risk and forecasting solutions for financial institutions while providing thought leadership on related trends in global financial markets.
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