Europe returns to the fold

12/10/2021

Despite the prevailing economic uncertainty being caused by COVID-19, Western European markets are in recovery mode. Societe Generale Securities Services [SGSS] looks at the main developments now underway across the key European markets along with some of the challenges they pose to investors.

Relative to some of the frontier and emerging markets in CEE [Central and Eastern Europe] and Africa, returns in the mature Western European economies continue to be subdued. Interest rates have been in perpetual decline across the region ever since the 2008 financial crisis with the ECB [European Central Bank] now even adopting negative rates1. Although equities in Western Europe have staged a recovery from COVID-19, the biggest challenge facing institutional investors nowadays is potential inflationary risk. Despite these pressures, there are excellent opportunities for investors in the region.

Digital assets – an opportunity in the waiting

Digital asset trading volumes – namely in crypto-currencies and StableCoins – have increased exponentially2. Although custodian banks are looking to develop asset servicing solutions to support crypto-currencies, the industry appears to be especially bullish on security tokens and central bank digital currencies [CBDCs]. But what are they? A security token is a digital unit conferring or representing value of an underlying asset such as a bond, equity, property or even fine art. As these security tokens can be divided into small units, they are less expensive to buy - in what could encourage greater retail participation in illiquid markets.  This in turn might help stimulate liquidity in these thinly traded assets, while enabling investors to diversify their portfolios beyond traditional assets.  Borne out of concerns about the proliferation of unregulated crypto-currencies, a number of Central Banks globally [and in Western Europe] are in the process of launching CBDCs – digital money which is supported and issued by Central Banks. Central Banks in Western Europe – including the ECB – are assessing the viability of establishing digital versions of their currencies. If successful, CBDCs could help expedite cross-border payments and settlements. Western Europe is widely considered to be one of the more mature markets when it comes to the development of securities tokens / CBDCs3.

In addition to proposing sensible, proportionate regulations to oversee digital assets [Markets in Crypto-Asset Regulation or MICA], the continent’s service providers are also conducting a range of POCs [proof of concepts] analysing real-world applications for these instruments. In partnership with Societe Generale, the European Investment Bank [EIB] issued a €100 million, two-year digital bond using public Blockchain technology for registration and settlement purposes. In a partnership with the Banque de France, the payment of the issue monies from the underwriters to the EIB was conducted using CBDCs.  More recently, Societe Generale and its subsidiary Societe Generale Forge supported a securities finance transaction for a digital bond issued - using Blockchain - by a German asset manager.

While transactional volumes remain low in some of the more institutional [e.g. regulated] digital assets, appetite will likely grow - as investors chase new return sources and seek out diversification.

Harmonisation picks up the pace

Regulation is playing a critical role in stimulating inward investment into Western Europe. One of the bigger barriers to have historically hindered cross-border investment inside the EU was the absence of proper regulatory harmonisation, especially in areas related to post-trade – [i.e. clearing and settlement. Since the 2008 financial crisis, huge efforts have been made to standardise a number of post-trade processes through regulation. The introduction of the Central Securities Depositories Regulation [CSDR] not only created a common regulatory framework for overseeing CSDs [central securities depositories] but it imposed a rolling T+2 settlement cycle across the EU, ahead of the introduction of Target2Securities [T2S], the ECB’s pan-EU securities settlement engine. Nonetheless, challenges persist with CSDR. In order to strengthen settlement discipline, the CSDR will impose a Settlement Discipline Regime [SDR], which will levy cash penalties and mandatory buy-ins on counter-parties responsible for failed trades from February 2022. While the industry largely supports the idea of penalties for settlement fails, there is apprehension about mandatory buy-ins for non-cleared trade fails with some – including AFME [Association for Financial Markets in Europe] warning it could increase costs and reduce liquidity. Amid these concerns, the European Securities and Markets Authority [ESMA] recently wrote to the European Commission urging it to delay the imposition of mandatory buy-ins owing to ongoing uncertainty about the regime. However, ESMA said it had no objections to introducing other elements of SDR including settlement fails reporting and cash penalties for fails.

Similarly, the roll-out of the Shareholder Rights Directive 2 [SRD2] – which is aimed at promoting better shareholder engagement and transparency – will also potentially usher in more harmonious standards across the EU for institutional investors. Among SRD2’s provisions are that intermediaries distribute information between issuers and investors more seamlessly, in what regulators argue will help make it easier for shareholders to exercise their rights. A number of markets have already successfully adopted the rules. However, there have been some challenges with the implementation of SRD2 inside the EU. For example, corporate action processes; general meeting practices and ISO 20022 adoption rates are quite varied across the EU, and this is leading to divergences in the region. Aside from strengthening shareholder rights, the EU is also keen to promote ESG [environment, social, governance] investing. It has done this through the introduction of ESG disclosure requirements for institutional investors following passage of the SFDR [Sustainable Finance Disclosure Regulations]. It will also unveil a Taxonomy outlining which economic activities it considers to be sustainable in what will provide an ESG benchmark for investors. With more institutions taking ESG seriously, the EU’s new policies could help accelerate investment in sustainable assets across member states and beyond.

Markets awash with opportunity

Western Europe’s positive approach to digital assets, ESG investing and post-trade harmonisation puts it in excellent stead moving forward. By working with providers such as SGSS who are in tune with new developments, and are willing to embrace change, investors and intermediaries will be in a strong position to navigate and capitalise on the changing dynamics currently sweeping through Western Europe. As a leading provider of securities services, SGSS has an excellent track record in participating in market advocacy efforts, supporting clients’ interests throughout the region. SGSS has continuously updated its systems and processes to reflect changes on the ground, both in terms of regulation and tax. This ensures that clients investing into Western Europe can do so as seamlessly as possible with minimal disruption. Through its extensive product suite, SGSS is a one stop solution for investors looking to build up their exposures to Western Europe.

 


Financial Times [July 22, 2021] ECB divisions open up over pledge to persist with negative rates

Financial Times [August 24, 2021) Crypto exchanges are booming, for now

PWC [April 2021] PwC CBDC Global Index

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