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International Association of Risk and Compliance
Professionals (IARCP)
1200 G Street NW Suite 800 Washington, DC 20005-6705 USA
Tel: 202-449-9750 www.risk-compliance-association.com
Top 10 risk and compliance management related news stories
and world events that (for better or for worse) shaped the
week's agenda, and what is next
Dear Member,
Standards are important for cyber
security, but there is a dark side too.
Friedrich Nietzsche has said that if you
gaze long enough into an abyss, the
abyss will gaze back into you.
On the positive side, there are many
reasons why standards have an important
role to play in information security.
Some of the more important reasons include:
• Improving efficiency and effectiveness of key processes.
• Facilitating systems integration and interoperability
• Enabling different products or methods to be compared in a meaningful
manner.
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• Providing a means for users to assess new products or services.
• Structuring the approach to deploying new technologies or business
models.
• Simplification of complex environments.
• Promoting economic growth.
Standardising processes and procedures is an essential part of achieving
successful cooperation in a cross-border or cross-community multi-vendor
environment.
Without such standardisation, communication is likely to be inefficient and
could result in a process that is ineffective.
On the negative side, any vulnerabilities associated with such systems will
also be ‘standardised’, making it possible to conduct attacks against large
numbers of systems in a short timescale.
The usual way of dealing with this however is not to avoid standardisation
but to ensure that the defences used to protect information systems are not
critically dependent on a single system or type of system – this is the
principle of defence in depth.
Read more at Number 6 below. Welcome to the Top 10 list.
Best Regards,
George Lekatis
President of the IARCP
General Manager, Compliance LLC
1200 G Street NW Suite 800,
Washington DC 20005, USA
Tel: (202) 449-9750
Email: [email protected]
Web: www.risk-compliance-association.com
HQ: 1220 N. Market Street Suite 804,
Wilmington DE 19801, USA
Tel: (302) 342-8828
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International Association of Risk and Compliance Professionals (IARCP)
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PCAOB Approves Reorganization of
Auditing Standards
Washington, DC, March 31, 2015
The Public Company Accounting Oversight Board approved the
reorganization of its auditing standards to help users navigate the
standards more easily.
The Board adopted amendments to its rules and standards to implement a
topical system that integrates the existing interim and PCAOB-issued
auditing standards.
The importance of the nonbank financial sector
Speech by Mr Stanley Fischer, Vice Chair of the Board
of Governors of the Federal Reserve System, at the
"Debt and Financial Stability - Regulatory Challenges"
conference, organized by the Bundesbank and the
German Ministry of Finance, Frankfurt am Main
“As you know, the euro area financial system differs from the U.S. system in
terms of the relative size and the role played by banks as compared with
nonbank financial institutions.
According to a recent report by the International Monetary Fund, banks in
the euro area accounted for roughly 75 percent of total lending by banks
and nonbanks that are part of the shadow banking system, whereas in the
United States, banks accounted for just under half this measure of total
lending in 2013.
The relatively large role played by nonbank financial institutions in the
United States brings with it both economic benefits and risks to financial
stability - risks that could be seen clearly during the Global Financial Crisis.
The nonbank sector in the United States was not always so large.”
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Statement on the Adoption of the
Reorganization of PCAOB Auditing
Standards
James R. Doty, Chairman
Open Board Meeting, Washington, DC
“The reorganization of the PCAOB's auditing standards under
consideration today is an important step in promoting the investing public's
interest in audit quality.
This reorganization provides auditors and others a logical framework and
easy access to the standards governing the conduct of audits.”
Agencies Permit Wells Fargo to Begin Using
Advanced Approaches Framework to Determine
Risk-Based Capital Requirements
The Federal Reserve Board and the Office of the Comptroller of the
Currency announced that they have permitted Wells Fargo and its
subsidiary national banks to begin using the “advanced approaches” capital
framework starting in the second quarter of 2015.
Under this framework, firms must meet specific risk-measurement and
risk-management criteria when calculating their risk-based capital
requirements.
The framework implements standards developed by the Basel Committee
on Banking Supervision and applies to large, internationally active banking
organizations--generally those with at least $250 billion in total
consolidated assets or at least $10 billion in total on-balance sheet foreign
exposure--and includes the depository institution subsidiaries of those
firms.
Before a banking organization may use the advanced approaches
framework, it must conduct a satisfactory trial, or “parallel run,” using the
framework.
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International Association of Risk and Compliance Professionals (IARCP)
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The Prudential Regulation
Authority publishes rules on
Solvency II
The Prudential Regulation Authority
(PRA) has published its final rules setting out how it will implement the
Solvency II Directive (Solvency II) in the UK.
Solvency II puts in place a consistent and coherent solvency framework for
insurers across Europe and aims to provide greater protection to
policyholders by reducing the probability of an insurance firm failure.
Standardisation in the field of
Electronic Identities and Trust Service
Providers
This paper explains why standards are important for cyber security,
specifically in the area of electronic identification and trust services
providers.
A number of challenges associated with the definition and deployment of
standards in the area of cyber security are discussed.
Recommendations on the equivalence of
confidentiality regimes
The successful and consistent functioning of colleges of supervisors as
provided for in Directive 2013/36/EC (Capital Requirements Directive) is a
key element for the complete and thorough supervision of institutions
belonging to cross-border banking groups.
The establishment of colleges of supervisors and their operating conditions
are set out in Article 116 of that Directive and in the relevant provisions of
the Commission Delegated and Implementing Regulations to be issued in
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accordance with paragraphs 4 and 5 of Article 116 of the Capital
Requirements Directive.
Grading the Commission’s Record on Capital
Formation: A+, D, or Incomplete?
Commissioner Daniel M. Gallagher
Vanderbilt Law School’s 17th Annual Law and Business
Conference
Nashville, TN
“I’d like to take some time to discuss with you what I view to be critical
capital formation issues facing the Commission.
The biggest news, of course, is that the Commission just two days ago
adopted final rules implementing Title IV of the JOBS Act, which required
us to revitalize the currently-moribund Regulation A offering exemption.”
Remarks of Secretary Lew Before Meeting
with Chinese Vice Premier Wang Yang
“Vice Premier Wang and I have become friends as we
have worked together over the past two years to
deepen our economic cooperation and ensure this relationship is one that
benefits citizens of both of our countries.”
Economic and monetary developments
With a view to pursuing the ECB’s price stability
mandate, the Governing Council has taken a
number of monetary policy measures to provide
a sufficient degree of monetary policy accommodation.
The combined monthly purchases of public and private sector securities
will amount to €60 billion.
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International Association of Risk and Compliance Professionals (IARCP)
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PCAOB Approves Reorganization of
Auditing Standards
Washington, DC, March 31, 2015
The Public Company Accounting Oversight Board approved the
reorganization of its auditing standards to help users navigate the
standards more easily.
The Board adopted amendments to its rules and standards to implement a
topical system that integrates the existing interim and PCAOB-issued
auditing standards.
"The standards will be organized by topics that generally follow the flow of
the audit process, making their use easier and more efficient for auditors,"
said PCAOB Chairman James R. Doty.
After considering the suggestions from commenters on the original
proposal and supplemental request, the Board adopted amendments to
reorganize the standards substantially as proposed.
"Moving forward, new auditing standards adopted by the Board will be
issued as new or replacement sections and paragraphs within the new
structure," said Martin F. Baumann, Chief Auditor and Director of
Professional Standards.
Under the reorganization, the individual standards will be grouped into the
following topical categories:
1. General Auditing Standards: standards on broad auditing principles,
concepts, activities, and communications
2. Audit Procedures: standards for planning and performing audit
procedures and for obtaining audit evidence
3. Auditor Reporting: standards for auditors' reports
4. Matters Relating to Filings Under Federal Securities Laws: standards on
certain auditor responsibilities relating to U.S. Securities and Exchange
Commission filings for securities offerings and reviews of interim financial
information
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5. Other Matters Associated with Audits: standards for other work
performed in conjunction with an audit
These amendments also remove references to superseded standards and
inoperative language and references.
They do not impose new requirements on auditors or change the substance
of the requirements for performing and reporting on audits under PCAOB
standards.
All amendments to PCAOB standards adopted by the Board are submitted
to the SEC for approval.
The amendments will be effective, subject to SEC approval, as of December
31, 2016.
If the amendments are approved, the PCAOB website would be updated for
the reorganized standards to allow audit firms to plan, or begin, their
transitions to the new numbering system.
The final rule and Board statements from the open meeting will be available
on the PCAOB website under Rulemaking Docket No. 040.
An archive of the webcast and a podcast of the Board meeting also will be
available later on the PCAOB website.
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International Association of Risk and Compliance Professionals (IARCP)
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The importance of the nonbank financial
sector
Speech by Mr Stanley Fischer, Vice Chair of the
Board of Governors of the Federal Reserve System,
at the "Debt and Financial Stability - Regulatory
Challenges" conference, organized by the
Bundesbank and the German Ministry of Finance,
Frankfurt am Main
It is a pleasure to be here. My subject is the important role the nonbank
financial sector plays in the United States financial system.
As you know, the euro area financial system differs from the U.S. system in
terms of the relative size and the role played by banks as compared with
nonbank financial institutions.
According to a recent report by the International Monetary Fund, banks in
the euro area accounted for roughly 75 percent of total lending by banks
and nonbanks that are part of the shadow banking system, whereas in the
United States, banks accounted for just under half this measure of total
lending in 2013.
The relatively large role played by nonbank financial institutions in the
United States brings with it both economic benefits and risks to financial
stability - risks that could be seen clearly during the Global Financial Crisis.
The nonbank sector in the United States was not always so large.
The U.S. financial system has changed significantly in recent decades, with
nonbanks as a whole gaining share and also becoming more interlinked
with banks.
This evolution has produced material benefits: increased market liquidity,
greater diversity of funding sources, and - it is often claimed - a more
efficient allocation of risk among investors.
However, the evolution has also increased threats to the stability of the
overall financial system, as demonstrated by the recent financial crisis.
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To promote financial stability, our tools for monitoring, regulation, and
crisis management have had to evolve in recent years, and they will need to
continue to evolve in the years to come.
Today I will describe how nonbank intermediation in the United States has
changed, what regulations are in place, and what reforms are under way to
address the risks to financial stability associated with the growth of the
nonbank sector.
The lessons we have learned about the U.S. nonbank financial sector may
be of interest to regulators in other countries who are promoting or reacting
to the changing composition of financing - away from banks and toward
nonbanks and market-based intermediation.
The role of nonbank financial intermediation in the U.S. financial
system
I apologize for starting by reminding us of material we all know.
First, the provision of credit to nonfinancial businesses and households is
critical to a well-functioning economy.
Indeed, Ben Bernanke's research on the Great Depression came to the
conclusion that it was the collapse of credit growth, rather than the slow
growth of the money supply, that was primarily responsible for the financial
crisis of the 1930s.
Second, the basic business model of a bank is straightforward: Banks take
deposits from their customers and invest the proceeds in the economy via
loans to businesses, households, and governments.
Therefore, a bank's balance sheet typically has shorter-term, highly liquid
deposits on the liability side and longer-term, illiquid loans on the asset
side.
This maturity transformation makes banks vulnerable to runs.
In recognition of this vulnerability, bank deposits became insured and the
lender of last resort function was extended to dealing with bank runs.
Third, nonbank financial institutions also act as intermediaries.
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Their importance as lenders has increased dramatically over the past 35
years.
Data from the Financial Accounts of the United States indicate that in 1980,
banks accounted for about 60 percent of total credit market assets held by
the domestic financial sector, while nonbanks held about 40 percent.
Certain nonbank financial institutions have long been important credit
providers; for example, in 1980, life insurance companies were vital to
corporate bond and commercial real estate markets, accounting for about
one-third of the debt outstanding in those two markets combined.
While insurance companies remained important, other types of nonbank
financial institutions, such as GSEs (government-sponsored enterprises,
primarily Fannie Mae and Freddie Mac) and mutual funds, rose in
prominence over the next few decades, so that total credit market lending
by nonbanks greatly outpaced lending by banks over the 1980s and into the
1990s. By the late 1990s, nonbanks held around two-thirds of total credit
market assets held by banks and nonbanks.
Their share has stayed relatively stable since then.
The nonbank financial system includes a diverse group of entities such as
insurance companies, finance companies, government-sponsored
enterprises, hedge funds, security brokers and dealers, issuers of
asset-backed securities, mutual funds, and money market funds.
They provide credit through markets - for example, by purchasing
commercial paper and bonds - or by extending loans directly to businesses
and to households.
These financial institutions evolved alongside banks, and their activities are
in many respects intertwined with those of banks.
Indeed, for every activity conducted by banks - with the exception of taking
government-insured deposits - a nonbank financial institution likely
conducts a similar activity.
In many cases, nonbanks engage in maturity and liquidity transformation
and are levered, so they have vulnerabilities similar to those of banks, but
lack the benefit of access to a lender of last resort.
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While banks may be more central to the payment system, nonbanks are also
involved.
Moreover, banks and nonbanks are interconnected in many ways - for
example, through derivatives, lines of credit, and other services provided by
banks to nonbanks - and many markets depend on banks that act as dealers
or that provide other services.
In addition, many nonbanks are owned by bank holding companies, which
may provide capital and liquidity guarantees to nonbank subsidiaries.
Not surprisingly, the growth of the nonbank sector has tended to increase
the complexity of the financial system.
When banks provide loans directly to households and businesses, the chain
of intermediation is relatively short and simple.
With the growth of nonbank lending, intermediation chains have
lengthened, often involving both banks and other nonbank financial
institutions.
For example, in the old days, a bank would originate a mortgage and hold it
in its portfolio.
Today, a bank might originate the same mortgage, but instead of holding
that loan on its balance sheet, it could securitize it - in effect, sell it - and the
resulting security might be purchased with the help of short-term funding
provided by a money market mutual fund.
And the process might not end there: Next that mortgage-backed security
might be sold and repackaged into several new securities, and so on.
In such examples, the number of institutions that might be involved in the
provision of a single mortgage credit can easily go from one (the originating
bank) to at least five or more.
And such long chains can create additional points of vulnerability in the
financial system.
Nonbanks also increase the amount of maturity transformation conducted
in the financial system without the stability-enhancing backstops offered to
banks.
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Although some nonbanks are eligible to obtain advances from the Federal
Home Loan Bank System, nonbanks are not backed by federal deposit
insurance, nor do they have direct access to a lender of last resort to stem
runs on their short-term liabilities.
As a result, their funding can dry up rapidly should counterparties begin to
believe the nonbank is in financial distress.
The failure of nonbank financial institutions could directly reduce the
availability of credit and could cause fire sales of assets leading to impaired
market functioning.
In addition, because many nonbanks are connected to banks, a shock to the
nonbank sector could in turn threaten the stability of the overall banking
system - as happened in the unfolding of the Global Financial Crisis.
Nonbanks and the start of the global financial crisis
Before discussing the role of non-banks in the Global Financial Crisis, let
me briefly mention a previous episode involving a non-bank - the failure of
Long-Term Capital Management (LTCM).
The New York Fed, under the leadership of then President William
McDonough, dealt successfully with the LTCM problem.
However the episode was scary and a warning about problems that could
arise in the nonbank financial system and spread wider.
Now to the Global Financial Crisis: Although there were many dimensions
to the financial crisis, the poor performance of subprime mortgages was one
of the triggers.
The fact that losses in what was a relatively small part of the mortgage
market quickly spread through the rest of the financial system illustrates
how the complex interconnections among banks and nonbanks can amplify
shocks in significant and unanticipated ways.
Some of the first cracks in the nonbank sector appeared in April 2007, when
New Century Financial Corporation, at one point the second-biggest
subprime mortgage lender, filed for bankruptcy after its creditors pulled
back on fears about its losses.
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A few months later, with subprime assets falling in value, money market
investors refused to roll over the asset-backed commercial paper that had
been funding many of these subprime assets.
With this market shrinking dramatically, the banking sector was left on the
hook to support entities that banks had sponsored or to which they had
provided some form of credit or liquidity support.
Around that same time, Bear Stearns, then one of the five largest
investment banks, liquidated two of its hedge funds that invested in
mortgage-based securities, including collateralized debt obligations,
another link in the chain of transactions.
In March 2008, some creditors stopped funding Bear Stearns, and forced
asset sales put additional downward pressure on asset prices.
By the dramatic month of September 2008, the chain of interconnections
had helped spread the financial pain, and a broader range of firms were
caught in the financial maelstrom.
Fannie Mae and Freddie Mac entered conservatorship. Lehman Brothers
failed when its creditors ran from it as they had from Bear Stearns.
American International Group, or AIG, had to be bailed out primarily
because of its inability to post enough collateral to cover liabilities on credit
protection it had sold on many entities (including Lehman) and because it
lost funding in the securities lending market.
The Reserve Primary fund, a money market mutual fund, "broke the buck"
as a result of its holdings of Lehman securities.
Banks were not immune to the financial market stress of this period, but
they were far less involved in the unfolding of the crisis than were nonbanks
- a phenomenon that highlighted the importance of the nonbank sector and
the vulnerability of the financial system to its distress.
When nonbanks pulled back, other parts of the system suffered.
When nonbanks failed, other parts of the system failed.
Regulatory reforms implemented in the wake of the financial
crisis
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A crisis as deep as the Global Financial Crisis was bound to produce
widespread regulatory changes.
It was clearly necessary to strengthen the banking system and to better
analyze and understand the importance of the links between the banking
sector and the nonbank financial sector.
With respect to the nonbank financial sector, there was a clear need for
greater transparency, less leverage, and more stable forms of liquidity
transformation.
One important change to the banking sector was the adoption of a
macroprudential perspective to supervision and regulation.
Central bankers and bank supervisors in the United States now regulate
and supervise large complex banks not only as standalone entities, but also
with consideration of how their actions could affect other firms and
activities in a highly connected financial system.
Within the Federal Reserve, a tangible manifestation of this
macroprudential approach is the LISCC - the Large Institution Supervision
Coordinating Committee - that was created specifically to coordinate the
supervision of the largest banks and other systemically important
institutions.
Other changes to the banking system in the United States include tighter
than Basel III capital and liquidity requirements, heightened prudential
standards for the largest banking firms, and stress tests.
Accounting standards and prudential regulations have also been changed to
require banks to recognize their links to nonbank entities, such as direct
connections or provision of back-up support.
Heightened prudential standards require the largest and most
interconnected banks to meet capital surcharges and stricter
risk-management standards than other banks.
Stress tests evaluate banks' ability to remain solvent and liquid when under
severe macroeconomic stresses and have incentivized better
risk-management and information systems within banks.
A variety of reforms have helped address risks in the nonbank sector as
well. I will touch briefly on three of those reforms.
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First, the United States has an unusually large number of independent
financial sector regulatory bodies.
There is accordingly an especially great need for efficient cooperation and
coordination among the various regulators that collectively oversee the
financial system.
In response to this need, the Dodd Frank Act created the Financial Stability
Oversight Council (FSOC) to help identify emerging risks and
vulnerabilities to financial stability.
The council's annual report on financial stability highlights risks and
vulnerabilities for the entire financial system and reflects the council's own
diverse nature:
Only 3 of the 10 voting members of the council are banking sector
supervisors, with the remainder supervising or having regulatory authority
related to credit unions, broker-dealers, asset managers, and derivative
market participants.
Among its decisions, the FSOC has designated four U.S. nonbank financial
institutions as systemically important financial institutions, which makes
them subject to consolidated supervision by the Federal Reserve Board.
In addition, the Dodd Frank Act mandated the establishment of the Office
of Financial Research in order to help promote financial stability through
the measurement and analysis of risks, the conduct of essential research,
and the collection and standardization of financial data.
A second nonbank reform has been the Securities and Exchange
Commission's (SEC) adoption of new rules for money market mutual funds.
Specifically, the SEC will require prime money market funds sold to
institutional investors to publish a floating net asset value and to restrict
withdrawals through a system of gates and fees.
These rules, while as yet untested, are designed to reduce the likelihood of
runs on prime money market funds.
The third nonbank reform I want to highlight relates to securitization,
which I mentioned earlier as one way in which parts of the financial system
can become interconnected.
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An important rule, finalized late last year, will require the securitizers of
some assets to retain at least 5 percent of the credit risk of the assets that
collateralize the securities.
With "skin in the game," the incentive to cut corners in extending loans is
reduced, and the entire chain created when assets are securitized should be
stronger.
Transparency has also been enhanced with stronger disclosure
requirements for securitizations.
At this stage of the recovery, there are signs of reduced nonbank financial
sector vulnerabilities.
Leverage is quite low in parts of the sector and appears moderate overall.
Leverage at hedge funds, while difficult to measure, is an exception and
appears in aggregate to have trended upward in recent years.
Market-level information on short-term wholesale funding - such as
commercial paper and repurchase agreements - indicate subdued activity
after its level fell dramatically during the crisis.
While issuance of securitizations has been picking up, its levels remains
moderate.
The available data paint a picture of a nonbank sector that has generally
reduced its vulnerability to the types of shocks that we saw during the crisis.
However, the nonbank sector is evolving in response to new regulations,
changes in investor preferences, and a multitude of other factors that are
always influencing the financial system.
For example, open-end mutual funds now hold a greater share of debt, and
more derivatives are being cleared through central counterparties.
These developments may ultimately prove to be stability enhancing, but as
the system evolves, we must remain attentive to the possibility of changes
that may be destabilizing.
More Needs to Be Done
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To say that the nonbank sector today appears less vulnerable than it did
during the Global Financial Crisis, is not to say that authorities in the
United States have tamed the nonbank sector.
Indeed, while progress has been substantial, areas for continued work
remain, and I will briefly highlight three of them.
Let me start with short-term wholesale funding markets.
While there have been some improvements in the plumbing of money
markets, many nonbank financial firms, including hedge funds and
broker-dealers, continue to rely on secured short-term funding to finance
their activities, many of which involve longer-term and illiquid assets.
This maturity transformation remains a key vulnerability.
Further, many of the firms that rely on this maturity transformation are
highly levered and thus more vulnerable to threats to their solvency.
The proposed international framework being developed by the Financial
Stability Board for margins on securities financing transactions may be an
important tool for limiting the pro-cyclicality and sharp deleveraging that
can occur in these markets.
Second, and more generally, we need to be alert to changes and trends in
the financial system that may pose risks to financial stability, particularly
those stemming from areas of the nonbank sector that are not subject to
prudential supervision.
For example, the asset management industry has both grown and evolved
in recent years.
Mutual funds and exchange-traded funds that track the returns of indexes
of relatively illiquid assets have mushroomed in size.
Examples include funds tracking the return on leveraged loans, credit
default swaps, and other less liquid assets.
These funds offer daily or even intraday liquidity to investors while holding
assets that are hard to sell immediately, thus making the funds vulnerable
to liquidity risk.
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Recently, the FSOC issued a notice seeking comment on the products and
activities of the asset management industry.
Third, there are also areas of the nonbank financial system into which we
have only a limited view.
While the data we have on hedge funds has improved, we still need to get a
complete picture of the scope and size of hedge fund activities.
Data coverage of the vast derivatives market could also be improved.
The paucity of information in some areas limits the ability of supervisors
and regulators to work effectively toward the stability of financial
institutions and the financial system.
For example, outside of the banking system, we have only limited
information on leverage and maturity transformation rather than precise
estimates for all types of nonbank entities.
Conclusion
To conclude, the U.S. financial system has changed a great deal over the
past several decades.
One of the most important changes has been the rapid growth of the
nonbank sector.
Many reforms have been adopted for both banks and nonbank financial
institutions.
But regulation is a cat and mouse game.
Regulators need to respond to existing regulatory gaps and to keep pace
with further changes.
We hope we will succeed in doing so.
But we know that we will never be able to identify in advance all the threats
to stability that are out there, and that it is therefore all the more critical to
maintain and strengthen the robustness of our financial institutions, and of
the financial system as a whole.
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Statement on the Adoption of the
Reorganization of PCAOB Auditing
Standards
James R. Doty, Chairman
Open Board Meeting, Washington, DC
The reorganization of the PCAOB's auditing standards under consideration
today is an important step in promoting the investing public's interest in
audit quality.
This reorganization provides auditors and others a logical framework and
easy access to the standards governing the conduct of audits.
I want to applaud the staff in the Office of the Chief Auditor who worked on
this project and staff in the Office of the General Counsel and the Center for
Economic Analysis who also provided valuable assistance. I would also like
to thank the SEC staff for their assistance and close consultation in this
effort.
It should come as no surprise to any professional person that auditing
literature is extensive.
This project involved the complicated task of reordering in a logical fashion
the robust volume of existing auditing standards that the profession
developed before the PCAOB was formed, and integrating these with the
many new auditing standards that the PCAOB has adopted in the 12 years
since.
Together, these standards consist of more than 1,000 pages of rule text.
Public comment on the proposed reorganization was helpful to ensure that
the new topical structure is intuitive and that auditing standards will be
easier to find.
In this regard, the project didn't stop with the intellectual framework of
reordering.
The reorganization involved more than 150 pages of numbering,
cross-referencing and other changes to present both the profession's
original standards and PCAOB-issued standards in the new framework.
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To assist users in evaluating the proposed changes in context, the staff
developed an online demonstration version of the reorganized auditing
standards.
Comments received on the demonstration version were also helpful in
promoting audit quality and compliance by allowing us to make sure that
auditors can easily navigate and find the applicable standards.
I am pleased that auditors and other users will no longer have to jump back
and forth between what we called "interim" standards and PCAOB-issued
standards.
The reorganization does not make additional work for auditors.
Rather, it should make professional practice easier.
We will now have one set of auditing standards under one integrated
framework.
Going forward we will change or add to those standards as needed,
consistent with our guidance on economic analysis.
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Agencies Permit Wells Fargo to Begin Using
Advanced Approaches Framework to Determine
Risk-Based Capital Requirements
The Federal Reserve Board and the Office of the Comptroller of the
Currency announced that they have permitted Wells Fargo and its
subsidiary national banks to begin using the “advanced approaches” capital
framework starting in the second quarter of 2015.
Under this framework, firms must meet specific risk-measurement and
risk-management criteria when calculating their risk-based capital
requirements.
The framework implements standards developed by the Basel Committee
on Banking Supervision and applies to large, internationally active banking
organizations--generally those with at least $250 billion in total
consolidated assets or at least $10 billion in total on-balance sheet foreign
exposure--and includes the depository institution subsidiaries of those
firms.
Before a banking organization may use the advanced approaches
framework, it must conduct a satisfactory trial, or “parallel run,” using the
framework.
Under the supervision of its regulator, a firm must show it can comply with
the framework during the parallel run period for at least four consecutive
calendar quarters by using risk-measurement and risk-management
systems that adhere to the advanced approaches framework.
Wells Fargo and Company and its subsidiary national banks (Wells Fargo
Bank Northwest, National Association; Wells Fargo Bank South Central,
National Association; Wells Fargo Bank, National Association; and Wells
Fargo Financial National Bank) have each completed a parallel run.
These firms will use the advanced approaches framework to calculate and
publicly disclose their risk-based capital ratios beginning in the second
quarter of 2015.
The firms must meet the minimum risk-based capital ratios under both the
advanced approaches and the generally applicable risk-based capital
frameworks.
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Prudential Regulation
Authority publishes rules on
Solvency II
The Prudential Regulation Authority
(PRA) has published its final rules setting out how it will implement the
Solvency II Directive (Solvency II) in the UK.
Solvency II puts in place a consistent and coherent solvency framework for
insurers across Europe and aims to provide greater protection to
policyholders by reducing the probability of an insurance firm failure.
The framework better aligns capital requirements to firms’ asset and
liability profiles and enhances the quality of capital, providing greater
protection.
It also provides incentives to strengthen risk management, reporting and
disclosure across the industry.
The policy statement sets out how the PRA will implement the ‘long-term
guarantees package’.
Insurers can reduce the level of risk on some types of long-term liabilities,
such as annuities, if they hold closely-matched, long-term assets to back
them.
The long-term guarantees package allows a firm to reduce its capital and
reserving requirements, where the firm is closely matched and invested for
the long term.
In addition to publishing the final rules, the PRA has also published a
consultation paper on the application process for the ‘volatility adjustment’.
This is an adjustment to the Solvency II risk-free discount rate which will be
used to value insurance liabilities.
It is designed to mitigate the effect of short-term volatility in financial
markets on valuation of insurers’ long-term liabilities under Solvency II.
A firm wishing to use the volatility adjustment can submit a formal
application after 1 April 2015.
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The PRA will assess applications on a case-by-case basis and will adopt a
proportionate approach to reviews.
The greater the impact of the volatility adjustment on the firm’s financial
position and risk profile, the greater the expected level of detail and
justification that firms will need to provide in the application.
The PRA will aim to make decisions on standalone applications (i.e. those
that are not dependent on other approval decisions) to use the volatility
adjustment within a six week timeline, rather than the statutory maximum
of six months.
The PRA recognises that firms may wish to submit both matching
adjustment (which allows firms to benefit from using assets held to
maturity in a portfolio backing illiquid liabilities) and volatility adjustment
applications.
The PRA will operate a harmonised approval process and will consider
these applications in parallel.
Andrew Bailey, Deputy Governor, Prudential Regulation, Bank of England
and CEO of the PRA said:
“Solvency II represents a fundamental change in the way that insurers are
regulated.
The papers published today provide clarity for UK firms on how the PRA
will implement the new regime – acting in the interests of the wider
economy and ensuring an appropriate level of policyholder protection.
These publications will allow firms to finalise their preparations for
Solvency II in order to be ready for the start of the regime on
1 January 2016.”
To learn more:
http://www.bankofengland.co.uk/pra/Pages/publications/ps/2015/ps215.
aspx
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Standardisation in the field of
Electronic Identities and Trust Service
Providers
This paper explains why standards are important for cyber security,
specifically in the area of electronic identification and trust services
providers.
A number of challenges associated with the definition and deployment of
standards in the area of cyber security are discussed.
This is followed by a brief overview of several key EU initiatives in this area
and a number of ENISA recommendations.
The paper also discusses concrete standardisation activities associated with
electronic IDs and trust service providers.
Standardisation in the field of Electronic Identities and Trust
Service Providers
Introduction
In the Cyber Security Strategy of the EU, the European Union reaffirms the
importance of all stakeholders in the current Internet governance model
and supports the multi-stakeholder governance approach.
Indeed, the multi-stakeholder approach is fundamental to the development
of successful standards, particularly in the area of cyber security where
public sector requirements are implemented to a large extent by private
sector service providers.
In the field of promoting a Single Market for cybersecurity products, the
cyber security strategy underlines the importance of the Cybersescurity
Coordination Group and ENISA.
It states, among others, that: “the Commission will support the
development of security standards”; “Such work should build on the
on-going standardisation work of the European Standardisation
Organisations (CEN, CENELEC and ETSI), of the Cybersecurity
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Coordination Group (CSCG) as well as on the expertise of ENISA, the
Commission and other relevant players”.
A number of EU governments are now promoting the broader adoption and
use of standards.
A good example is a standardisation policy for software interoperability,
data and document formats in government IT specifications, published by
the UK government.
Standards also play an important role in the EU’s Digital Agenda.
Quoting the then European Commission’s Vice President Neelie Kroes, they
“create competition, lead to innovation, and save money”.
Within the private sector, industrial interest in standardisation activities in
the area of NIS tends to be driven by areas of work that are in line with the
core interests of product developers or service providers.
Aligning public sector goals with standardisation priorities of the private
sector remains challenging.
Where information security is concerned, there is clearly room for
improvement in identifying and responding to evolving risks and
technology developments.
In particular, the time lag between the appearance of a new technology or
technically driven business model and the availability of applicable
standards is still too long.
Importance of standards in information security
There are many reasons why standards have an important role to play in
improving approaches to information security that involve different
geographical regions or different communities.
Some of the more important reasons include:
• Improving efficiency and effectiveness of key processes.
• Facilitating systems integration and interoperability
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• Enabling different products or methods to be compared in a meaningful
manner.
• Providing a means for users to assess new products or services.
• Structuring the approach to deploying new technologies or business
models.
• Simplification of complex environments.
• Promoting economic growth.
Standardising processes and procedures is an essential part of achieving
successful cooperation in a cross-border or cross-community multi-vendor
environment.
Without such standardisation, communication is likely to be inefficient and
could result in a process that is ineffective.
An illustrative example is provided by the way in which different countries
would react to a significant cyber incident.
Here, in line with the principle of subsidiarity and the need to preserve
sovereign state control, decision making is made in a distributed
environment and the processes that support this process must be optimal.
Standardised operating procedures could help ensure that various
countries can interact with each other according to one set of predefined
and agreed procedures.
Similarly, specifications such as ISO 27001 encourage the adoption of a
standard organization structure, which makes it easier for customers to
understand how processes work and also reduces the costs of auditing and
due diligence.
This is largely due to the fact that these organisational standards provide a
blue-print for setting up a management system for security, but also for a
blueprint for auditing and checking compliance of an organisation to
security best practices.
Standards play a key role in ensuring that security products can be put
together into systems capable of detecting and responding to real events.
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In particular, standard interfaces and protocols make systems integration
much simpler and allow products to interoperate in heterogeneous
environments.
Standardisation of testing methods also makes it possible to compare
security products in a meaningful manner (‘benchmarking’) and provide a
means for the end user to assess new products or services.
The level of compatibility of cryptographic modules with the FIPS 140-2
standard (which is used to accredit such products) for instance is used to
assess the ability of such products to meet certain security requirements.
By structuring the approach to deploying new technologies or business
models, standards help to reduce the complexity of the business
environments that deploy them, which in turn makes it easier to secure the
resulting environment.
Although there is also an argument against standardisation in this respect,
notably that any vulnerabilites associated with such systems will also be
‘standardised’, making it possible to conduct attacks against large numbers
of systems in a short timescale.
The usual way of dealing with this however is not to avoid standardisation
but to ensure that the defences used to protect information systems are not
critically dependent on a single system or type of system – this is the
principle of defence in depth.
Last but not least, the use of standards encourages information exchange
among developers and it is likely to result in greater competition among
product developers.
All these factors have a great impact on the overall preparedness of the
governments to the cyber threat.
Standardised technologies and approaches enhance harmonisation among
cooperating countries, ensure a larger pool of experts available and higher
level of knowledge of systems deployed.
Standardisation challenges in Cyber Security
Despite the fact that an appropriate use of standards is clearly beneficial to
achieving a strong approach to security in a cross-border environment,
there are also many challenges to achieving this in practice.
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Organisational challenges
Over the last ten years a plethora of SDOs (Standard Development
Organisations) have been created. In many occasions these organisations
have been initiated by industry (e.g. Oasis, W3C, Open Data Center, IETF,
Adobe, ITIL and many others) to a certain extent as a reaction of the
industry to the large investment in terms of time and people required by
‘traditional’ SDOs (such as ETSI, CEN-CENELEC, ISO, ITU) and partially
the result of convergence where standardisation fora that traditionally
focused on a specific sector (e.g. IEEE) found applicability in many
different business sectors.
The number of SDOs and the number of published standards has increased,
which can be a source of confusion to end users.
Areas of standardisation
Industrial interest in standardisation activities in the area of NIS tends to
be driven by areas of work that lay in line with the core interests of service
providers (for example authentication, billing, etc.).
Although an increased general interest in the area of privacy is observed,
specific interest of industry is expected to become lower since privacy
enhancing technologies are perceived as being in conflict with commercial
expectations.
At the time of writing, there is no single, continuous “line of standards”
related to cyber security, but rather a number of discrete areas which are
the subject of standardisation:
• Technical standards
• Metrics (related mostly to business continuity)
• Definitions
• Organisational aspects
Some areas could be potentially considered as over-standardised.
There are several standards on information security governance and risk
management.
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In some areas standards are lacking, for example there are relatively few
standards that deal with compliance to privacy and data protection
legislation.
Similarly, there are not many standards covering service levels, or more
broadly, service agreements and service contracts, terms of use and
conditions, et cetera.
A quick look across the different offerings of cloud providers will show that
every provider has a different lengthy legal text describing the terms of use
and exceptions to obligations.
Lack of agility
Designing and agreeing standards is a lengthy process, measured in years.
The IT landscape on the other hand evolves rapidly and, in order to remain
useful, standards need to evolve at a comparable pace.
Failure to do so will result in standards that are either obsolete or only
partially applicable to real life environments.
One solution to this issue could be sought in the direction of using ‘good
practices’ as precursors for standards.
Good practicesare generally subjected to change control procedures that are
much less stringent than those applied to candidate standards and could
therefore be developed to maturity more quickly.
Good practices that are sufficiently mature could then be used as a basis for
a corresponding standard.
With regard to standards, a ‘fast track’ mechanism could be developed and
agreed among interested parties, to be able to publish non-controversial
standards in a quicker manner.
Competing sets of standards
In some areas of information security there are several different groups of
standards that are defined.
To some extent, these standards are competing with each other for
adoption and it is often difficult for the end user to judge which standards
are the best choice for their particular requirements.
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Occasionally, it is necessary to mix and match standards from different
families in order to achieve the goal.
When implementing Public key Infrastructure (PKI) for instance, it is not
unusual to see organisations adopt such a combination of standards (for
example X.509 (ITU) for the certificate format, PKIX (IETF) standards for
core PKI and PKCS (RSA) standards for interfacing to secure devices).
Economic considerations
Although some providers see their use of recognised standards as a unique
selling point, there are also many cases of vendors who have a dominant
position, who insist on their own proprietary standards and fail to
constructively support and implement standards for their products.
For instance, the fact that every mobile phone vendor uses different charger
plugs is annoying for consumers, and it is wasteful in terms of resources.
In order to resolve this situation, the EU followed up an industry initiative
to adopt a single standard universal mobile phone charger plug.
Companies with a dominant position have few incentives to adopt
interoperable standards, because it would only reinforce the position of
competitors.
For a dominant vendor there are advantages to using proprietary
standards, because they lock-in the customer.
Lock-in means that:
• The customer cannot buy or integrate with compatible products from
competitors, which generates more revenue for the provider.
• It is hard for customers to switch to another supplier, because they cannot
easily move their data and processes to a competitor.
Lack of awareness
Despite the clear disadvantages associated with the use of proprietary
standards, there are still many examples of cases where customers
(especially in this context we consider as ‘customers’ national authorities,
governmental organisations, etc.) fail to demand open standards.
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This may well be due to a lack of awareness of the existence of such
standards.
Cyber security strategy of the European Union
The European Commission published the Cybersecurity strategy of the
European Union5 on 4 February 2013.
This strategy provides a harmonised framework for the evolution of three
different aspects of cyber security, which until recently had been evolving
independently.
In so doing, the Commission recognised and responded to the need to bring
different communities together to improve the approach to cyber security
across the EU and laid the foundations for a more coordinated approach.
The Cyber Security Strategy of the EU also includes a proposal for a
Directive on Network and Information Security (NIS) requiring the
Member States (MS) to have minimum NIS capabilities in place, to
cooperate and exchange information within a dedicated network and
requiring the private sector to adopt NIS enhancing actions.
• The EU reaffirms the importance of commercial and non-governmental
entities, involved in the day-to-day management of Internet standards
• A prime focus should be to create incentives to carry out appropriate risk
management and adopt security standards and solutions, as well as
possibly establish voluntary EUwide certification schemes building on
existing schemes in the EU and internationally
• the Commission will support the development of security standards and
assist with EUwide voluntary certification schemes in the area of cloud
computing
Under strategic objective 4, the Commission asks ENISA to ‘develop, in
cooperation with relevant national competent authorities, relevant
stakeholders, International and European standardisation bodies and the
European Commission Joint Research Centre, technical guidelines and
recommendations for the adoption of NIS standards and good practices in
the public and private sectors.’
This is a timely recommendation as the new ENISA mandate gives the
Agency a more proactive role in this area.
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The task assigned to ENISA by the new ENISA regulation in this area is to
‘support research and development and standardisation, by facilitating the
establishment and take up of European and international standards for risk
management and for the security of electronic products, networks and
services’.
There are also recommendations for public and private stakeholders.
In particular ‘The Commission invites public and private stakeholders to:
• Stimulate the development and adoption of industry-led security
standards, technical norms and security-by-design and privacy-by-design
principles by ICT product manufacturers and service providers, including
cloud providers; new generations of software and hardware should be
equipped with stronger, embedded and user-friendly security features.
• Develop industry-led standards for companies' performance on
cybersecurity and improve the information available to the public by
developing security labels or kite marks helping the consumer navigate the
market.
• An important part of the cyber security strategy is the proposal for a
Network and Information Security (NIS) Directive.
This Directive asks the Member States to support standardisation in the
area of NIS:
• Given the global nature of NIS problems, there is a need for closer
international cooperation to improve security standards and information
exchange, and promote a common global approach to NIS issues.
Standardisation of security requirements is a market-driven process.
To ensure a convergent application of security standards, Member States
should encourage compliance or conformity with specified standards to
ensure a high level of security at Union level.
To this end, it might be necessary to draft harmonised standards.
Article 16 on standardisation states the following:
• …..Member States shall encourage the use of standards and/or
specifications to networks and information security. • The Commission
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shall draw up, by means of implementing acts a list of the standards
referred to in paragraph 1.
The list shall be published in the Official Journal of the European Union
Cyber Security Coordination
Group In 2011, following a request of the Commission, the Standards
Development Organizations (SDOs) CEN, CENELEC and ETSI have
created the CEN‐CENELEC‐ETSI ‘Cyber Security Coordination Group’
(CSCG) for strategic advice in the field of IT security, Network and
Information Security and cyber security.
The main objectives of the CSCG are to
• Establish a European standardisation roadmap in the above mentioned
areas
• Act as the main contact point for all questions by EU institutions related
to standardisation issues
• Define and propose to the Commission a cooperation strategy between the
EU and the US for the establishment of a framework, relating to
standardisation of cyber security.
The European Union Agency for Network and Information Security
(ENISA) has participated and contributed to the activities of the CSCG
since its launch.
A first white paper was addressed by the members of CSCG to the
Commission with strategic advice on the priorities for R&D of EU funded
research in the area and how to optimise EU research with mandates for
cyber security standardisation.
Strategy towards standardisation options
One of the issues that the European Union needs to address is the strategy
towards standardisation in the area of ICT.
The current approach is not consistent and lacks a unified vision.
In this light the EC has taken an initiative in 2011 in order to promote a
coordinated approach at EU level.
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For this purpose the Commission (DG CONNECT) supported also by
ENISA has identified possible alternatives and options briefly summarized
below.
High level strategic options for recommendations on security standards
could be:
1. General recommendations
They can only be applied to specific cases, otherwise they are not
considered by any communities, no more than very generic
recommendations on security in general.
2. Recommendations targeting organizations (such as ISO 27000
for the management of information security or ISO 31000 for risk
assessment within organizations)
Very costly and possibly limiting innovations.
This option has a lot of potential if implemented in a correct (and
acceptable by industry) way.
A European framework for standards would be ‘nice to have’ on one hand,
but on the other would be very costly, would require a lot of resources (in
terms of research and following-up related activities).
However, the adoption of standards could be enforced by the European
legislation and national competent authorities (for example requiring
defined standards to be applied in order to get authorization to perform
certain activities, like provision of ICT services).
3. Specific recommendations for products / services with
dedicated standards (similar to Common Criteria)
Complicated approach presenting (among others) a problem in the
definition of specific products or services. In the world where most ICT
services are converging, identifying a ‘class’ of products is a challenge.
4. Recommendations on functions / products / services using a
mash-up approach
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Such a “mash-up" approach could be an ad hoc solution, where functions,
products, services would need to be selected following an appropriate
process.
At the EU level it is important to take advantage of Framework Programs of
EU funded R&D by funding flagship project/initiatives with clear
standardization objectives.
The additional benefit of this approach is that by definition these research
projects have strong industrial participation that could be also ‘channeled’
towards strategic standardization initiatives.
For example in the area of Attribute Based Credentials (ABC) the
Commission is funding an interesting Integrated Project that makes use of
IPRs of US based companies (mainly MS and Intel).
Even in such (difficult) cases all efforts should be made for strategic
contributions at ETSI.
To read more:
file:///C:/Users/George-Lekatis/Desktop/Standardisation%20-%20eIDAS
.pdf
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Recommendations on the
equivalence of confidentiality
regimes
Executive summary
The successful and consistent functioning of colleges of supervisors as
provided for in Directive 2013/36/EC (Capital Requirements Directive) is a
key element for the complete and thorough supervision of institutions
belonging to cross-border banking groups.
The establishment of colleges of supervisors and their operating conditions
are set out in Article 116 of that Directive and in the relevant provisions of
the Commission Delegated and Implementing Regulations to be issued in
accordance with paragraphs 4 and 5 of Article 116 of the Capital
Requirements Directive.
In this regard, facilitating the participation of third-country supervisory
authorities in the colleges is expected to significantly increase the efficiency
and effectiveness of the supervisory work conducted in the colleges.
The EBA is, in accordance with Regulation (EU) No 1093/2010 (EBA
Regulation), tasked with promoting the efficient, effective and consistent
functioning of the colleges of supervisors and ensuring the consistent
application of European Union law within those colleges.
Furthermore, the EBA is tasked with providing assistance on the issue of
equivalence.
To carry out its tasks, the EBA may employ various tools, including
recommendations, in accordance with Article 16 of the EBA Regulation.
To perform its role, the EBA is in the process of assessing and evaluating
the equivalence of the confidentiality regimes of third-country supervisory
authorities, primarily for the operational purposes of the colleges and for
the participation of third-country supervisory authorities therein.
The EBA aims to complete the assessment of the equivalence of the
confidentiality regimes for a number of third-country supervisory
authorities within the next two years and to issue relevant
recommendations in due course.
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The Recommendations in this document on the equivalence of
confidentiality regimes (the Recommendations) are being issued following
the completion of the first round of assessments of several third-country
supervisory authorities.
The Recommendations exclusively concern the assessment of the
confidentiality regimes of those third-country supervisory authorities with
a view to inform the relevant opinions, which competent authorities that
are members of a college of supervisors should express pursuant to Article
116(6) of the Capital Requirements Directive.
The Recommendations do not provide any form of guidance on the
appropriateness of such participation as referred to in Article 116(6).
This issue is to be determined by the college of supervisors alone, taking
into account the overall structure of the supervised group and the
applicable legislation.
Background and rationale
Article 116(6) of the Capital Requirements Directive provides the following:
‘The competent authorities responsible for the supervision of subsidiaries
of an EU parent institution or an EU parent financial holding company or
EU parent mixed financial holding company and the competent authorities
of a host Member State where significant branches as referred to in Article
51 are established, ESCB central banks as appropriate, and third countries'
supervisory authorities where appropriate and subject to confidentiality
requirements that are equivalent, in the opinion of all competent
authorities, to the requirements under Chapter 1, Section II of this Directive
and where applicable, Articles 54 and 58 of Directive 2004/39/EC, may
participate in colleges of supervisors.’
The EBA shall, under Article 21 of the EBA Regulation, promote the
efficient, effective and consistent functioning of the colleges of supervisors
and foster consistent application of European Union law within the colleges
of supervisors.
For that purpose, and in accordance with paragraph 3 of Article 21 of the
EBA Regulation, the EBA may exercise its powers, in particular to issue
guidelines and recommendations in accordance with Article 16 of the EBA
Regulation and to promote convergence in supervisory functioning and
best practices adopted by the colleges of supervisors.
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Furthermore, the EBA shall provide assistance, in accordance with Article
33 of the EBA Regulation, on equivalence issues.
There are two main conditions to be met for the participation of a
third-country supervisory authority in a given college:
(1) the appropriacy of that participation and
(2) the authority being subject to a confidentiality regime which is deemed
equivalent in the opinion of the competent authorities to the one provided
by the Capital Requirements Directive.
These Recommendations do not include guidance on the determination of
the appropriacy of participation of a thirdcountry supervisory authority in a
given college of supervisors.
They do, however, provide guidance that should inform the opinions of
competent authorities on the equivalence of the confidentiality regime
applicable to a particular third-country supervisory authority, whose
participation in a given college is to be determined under Article 116(6) of
the Capital Requirements Directive.
Equivalence of the confidentiality regime of any third-country supervisory
authority participating in a college is a key element to ensure the safe and
secure flow of information within that college.
Promoting convergence in this matter is absolutely necessary to eliminate
inconsistency in approaches, which could result in legal uncertainty and
could cause practical impediments to the exchange of information and,
ultimately, to the efficient, effective and timely functioning of the colleges of
supervisors.
The EBA has performed its assessment to evaluate the professional secrecy
and confidentiality regime applicable to each third-country supervisory
authority included in these Recommendations.
The assessment of equivalence was based on the factors below, deemed to
be the key characteristics of the Capital Requirements Directive
confidentiality regime.
In particular it was assessed whether the legal regime applicable to each
third-country supervisory authority:
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i) contained the notion of confidential information;
ii) contained specifications on the existence of professional secrecy
obligations;
iii) restricted the use of confidential information; and
iv) established restrictions on the transfer of confidential information.
These Recommendations are issued on the basis of Article 16 of the EBA
Regulation and are aimed at informing the opinion of the competent
authorities, as referred to in Article 116(6) of the Capital Requirements
Directive.
The EBA expects to receive confirmation of the competent authorities’
compliance or of their intention to comply irrespective of whether an actual
case of college participation exists.
Recommendations on Equivalence of Confidentiality Regimes
Status of these Recommendations
This document contains recommendations issued pursuant to Article 16 of
Regulation (EU) No 1093/2010 of the European Parliament and of the
Council of 24 November 2010 establishing a European Supervisory
Authority (European Banking Authority), amending Decision No
716/2009/EC and repealing Commission Decision 2009/78/EC (‘the EBA
Regulation’).
In accordance with Article 16(3) of the EBA Regulation, competent
authorities and financial institutions must make every effort to comply with
the recommendations.
Recommendations set out the EBA’s view of appropriate supervisory
practices within the European System of Financial Supervision or of how
Union law should be applied in a particular area.
The EBA therefore expects all competent authorities and financial
institutions to whom recommendations are addressed to comply with these
recommendations.
Competent authorities to whom recommendations are addressed should
comply by incorporating them into their supervisory practices as
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appropriate (e.g. by amending their legal framework or their supervisory
processes), including where recommendations are directed primarily at
institutions.
Reporting Requirements
According to Article 16(3) of the EBA Regulation, competent authorities
must notify the EBA as to whether they comply or intend to comply with
these recommendations, or otherwise with reasons for non-compliance, by
02.06.2015.
In the absence of any notification by this deadline, competent authorities
will be considered by the EBA to be non-compliant.
Notifications should be sent by submitting the form provided at Section 5 to
[email protected] with the reference ‘EBA/REC/2015/01’.
Notifications should be submitted by persons with appropriate authority to
report compliance on behalf of their competent authorities. Notifications
will be published on the EBA website, in line with Article 16(3).
Title I - Subject matter, scope and definitions
1. These Recommendations are issued on the basis of Article 21 and 16 of
Regulation (EU) No 1093/2010 1 and aim at ensuring convergence of the
functioning of the members of a college when the latter provide their
opining in accordance with Article 116 (1) of Directive 2013/36/EU2 for the
purposes of participation in a college of third country supervisory
authorities listed in the ANNEX.
2. These Recommendations are addressed to competent authorities as
referred to in Article 4(2) of Regulation (EU) No 1093/2010.
Title II- Assessment of Equivalence of Confidentiality Regime
3. Competent authorities should, when issuing their opinions referred to in
Article 116 (6) of Directive 2013/36/EU, consider that the confidentiality
regime applicable to third country supervisory authorities listed in the
ANNEX is equivalent to the confidentiality requirements set out ub Chapter
I, Section II of that Directive.
Title III- Final Provisions and Implementation
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4. These Recommendations apply from 01/04/2015
To learn more:
http://www.eba.europa.eu/documents/10180/1032035/EBA-REC-2015-0
1+Recommendations+on+the+equivalence+of+confidentiality+regimes.pd
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Grading the Commission’s Record on
Capital Formation: A+, D, or Incomplete?
Commissioner Daniel M. Gallagher
Vanderbilt Law School’s 17th Annual Law and
Business Conference
Nashville, TN
Thank you, Jim [Cheek] for that kind
introduction. It is an honor to be here at
Vanderbilt today.
Not only because Vanderbilt is such a distinguished university, but because
it is home to a dear friend of mine, Craig Lewis.
As Director of the SEC’s Division of Economic and Risk Analysis, Craig did
more to transform the agency — in particular by crafting a new paradigm
for cost-benefit analysis in the work of the Commission — than any other
staffer in the Commission’s recent history.
I miss having Craig at the SEC — our loss is truly Vanderbilt’s gain — but his
successor Mark Flannery is doing a great job running with the baton that
Craig passed to him.
It is also nice to be in Nashville. It’s always refreshing to get away from the
often-acrimonious debates inside the Beltway and hear some straight talk
from real entrepreneurs trying to grow their businesses.
So later today, as part of what I’ve been calling my capital formation
listening tour, I’m going to the Nashville Chamber of Commerce to meet
with some of these folks and hear what they have to say about how we could
be doing our job better.
But, right now, I’d like to take some time to discuss with you what I view to
be critical capital formation issues facing the Commission.
I. Regulation A+ and Venture Exchanges
The biggest news, of course, is that the Commission just two days ago
adopted final rules implementing Title IV of the JOBS Act, which required
us to revitalize the currently-moribund Regulation A offering exemption.
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According to a GAO report, old Regulation A suffered from several flaws,
including a lack of preemption of state blue sky regulation, and an
inadequate $5 million cap on the size of the offering.
As between a Regulation A offering and an unlimited, state-preempted
private placement under Rule 506 of Regulation D, the choice was a
no-brainer.
I am very pleased that the Commission was finally able to adopt changes to
Regulation A to substantially resolve several of the key issues that
previously afflicted the rule.
The cap on the size of the offering has been raised to the statutory
minimum of $50 million, and offers and sales for so-called “Tier 2” issuers
preempt state blue sky law.
The latter point is critical: issuers looking to make a nationwide offering
need only have their offerings qualified by the SEC; they do not need to
undergo the review processes, including merit review, of 50+ securities
regulators.
We’ve also given these issuers a conditional exemption from Section 12(g)
of the Exchange Act, so that Tier 2 issuers have some breathing room to
raise capital and grow without triggering the burden of full Section 13
reporting requirements.
I am thrilled about this development. But, as I noted at the open meeting,
the rule is not as good as it could have been.
Three years after the law was enacted, we should have exercised our clear
authority under the JOBS Act to raise the offering limit to $75 million.
We should have deemed Regulation A’s semiannual reporting to be
“reasonably current” for purposes of Rules 15c2-11, 144, and 144A.
And, we should have allowed reporting issuers to use Regulation A.
But putting these and some other issues aside, in this era of regulatory
excess, it is refreshing to see the Commission finally taking action to
facilitate capital formation.
That being said, this is no time to rest on our laurels. We still have a lot to
accomplish in order to ensure that Regulation A is a success.
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First, setting aside the problems I’ve just mentioned, I expect that
additional issues will crop up in practice, despite heroic efforts by some of
the brightest and hardest-working staffers at the SEC to anticipate and
resolve everything in advance.
I want Regulation A to achieve its goal of being a meaningful, quasi-public
means of capital formation.
So, as companies begin to make use of these new rules to raise capital, if you
find inefficiencies in our final regulatory scheme, please raise them soon,
and raise them loudly.
Second, as I’ve mentioned many times before, the revisions to Regulation A
were targeted at enhancing the primary issuance of securities.
But if we could significantly enhance secondary market liquidity for these
shares, we could invigorate Regulation A even further.
Investors will be more likely to purchase securities, and at a higher price, if
they know they can readily exit their investment.
For this reason, I continue to believe that venture exchanges are the answer
to this secondary market liquidity conundrum.
I was delighted to see the SEC’s Advisory Committee on Small and
Emerging Companies take up the issue of secondary market liquidity for
small company shares, in particular the Committee’s emphasis on venture
exchanges.
There also appears to be sincere interest in this idea by the Commission and
it has been a hot topic in Congress lately.
Simply put, there is a real need to pursue venture exchanges for small
companies.
The old, tired arguments against them are simply defenses of the status quo
by those who either benefit from the status quo, or who can’t escape the
past.
The Commission can and should pursue the creation of venture exchanges,
and I assume that, if we do not, Congress would be more than happy to do it
for us, just as they did on other issues in the JOBS Act.
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There is one obvious piece of unresolved business in our Regulation A rule:
it does little to facilitate capital formation for Tier 1 issuers.
These issuers still have to navigate state blue sky law qualification, on top of
the SEC’s review and qualification.
There has been improvement to that process, but it did not come from the
SEC.
The new NASAA coordinated review program, from the limited sample set
we’ve seen so far, appears to bring some speed and predictability to the
states’ filing review.
But, agreeing to participate in the coordinated review program means that
issuers must undergo merit review.
Merit review, of course, has given investors such gems as the prohibition on
the sale of Apple IPO shares in Massachusetts.
How’d that work out?
Moreover, the lack of preemption for offers under Tier 1 — which is worse
than the proposal — means that issuers would have to look to state law to
determine if they may benefit from the “testing the waters” provisions of
Regulation A.
The increased size of the Tier 1 offering may prove useful for issuers looking
to raise between $5 and $20 million in capital, as the larger offering size
will help further defray the costs of undergoing the full qualification
process.
We can also help this segment of issuers by closely supervising the
implementation of the coordinated review program.
If NASAA cannot get all jurisdictions on board, and keep them on board —
that is, if states start refusing to defer to the conclusions of the primary
reviewers — then the SEC should reexamine whether to preempt state law
in Tier 1 as well.
Ultimately, however, for an issuer looking to raise $0 to $5 million in
capital under Regulation A — that is, within the scope of old Regulation A —
our new rules don’t do much to help facilitate capital formation.
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Tier 1, with state qualification, remains too expensive; and Tier 2, with
ongoing reporting, will likely be too expensive as well. This is unfortunate.
One solution would be to look at paradigms other than Regulation A, which
seem to offer much more promise in helping the smallest companies raise
money.
II. Raising Under $5 Million in Capital Shouldn’t Be So Hard
A.Crowdfunding
I’ll lead off with the obvious one: crowdfunding.
Crowdfunding is a bit of a paradox right now.
Accredited investor crowdfunding, a consequence of the JOBS Act mandate
to lift the general solicitation ban under Rule 506, has really taken off.
Crowdfunding to non-accredited investors under Title III of the JOBS Act
is, of course, still stuck in SEC rulemaking limbo.
Not because the Commission lacks the will to move forward, but rather due
to the weight of the accumulated, nanny state investor “protections” thrown
into the JOBS Act mandate by the Senate.
Although Rule 506(c) was not specifically intended to facilitate
crowdfunding, the rule’s flexibility has given rise to a robust and growing
crowdfunding industry.
When you contrast the regulatory framework of Title III crowdfunding with
Rule 506(c) crowdfunding, the latter is much more flexible.
Of course, some will say it is the Wild West.
To me, though, it is a great example of the creativity and ingenuity of the
markets and market participants.
And:
(1) the antifraud laws still apply,
(2) accredited investor verification needs to be complied with,
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(3) no “bad actors” can be involved,
(4) Form D must be filed,
(5) and so forth.
Even the Wild West had its lawmen, as difficult as it may be to picture
Andrew Ceresney as Wyatt Earp!
If 506(c) crowdfunding is the Wild West, Title III crowdfunding is 1970s
East Germany.
The heavy hand of the state is omnipresent and smothering.
As amended by the Senate, Title III gets the theory of crowdfunding wrong,
overlaying the usual issuer disclosure and broker-dealer regulatory regimes
on crowdfunding transactions and intermediaries.
The result is an over-engineered regulatory approach.
The wisdom of the crowd has been displaced by the all-knowing
Washington book club.
And so non-accredited investor crowdfunding, if adopted as proposed, is
widely anticipated to be too burdensome for the smallest companies.
Certainly, we can draw from our experience with Rule 506(c) crowdfunding
to help inform rulemaking here; it may also be worthwhile to look to the UK
FCA’s approach to crowdfunding, which has been operating successfully
with a very light touch regime.
A less prescriptive statute would of course greatly ease our ability to make
Title III crowdfunding work, and perhaps Congress will look at this issue.
B. Regulation D Exemptions
Despite all the attention paid to Rule 506 offerings, there are two other
small issues exemptions in Regulation D. Rules 504 and 505 permit capital
raises of up to $1 million and $5 million, respectively — the former with
general solicitation if registered with the states, and the latter without.
The available data show that these rules are infrequently used; issuers
much prefer to use Rule 506 for offerings of any size.
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This is, I believe, directly attributable to the lack of state law preemption.
To fix these rules, we need to better balance the costs and benefits of each of
these exemptions.
For example, we could consider preempting state blue sky laws, raising the
offering caps, and expanding the availability of general solicitation —
similar to what we have now for Regulation A and Rule 506(c).
Of course, there are some who take a different view: that the registration
and reporting obligations of the SEC are Holy Writ, making exemptions
therefrom akin to blasphemy.
Exemptions, in their view, should be tightly cabined, in order to force
securities issuance into registered offerings.
Rather than raising up Rules 504 and 505, they would rather see Rule 506
brought low.
It was this view in particular that animated the stifling Regulation D
amendments that were proposed in 2013, contemporaneously with our
lifting the ban on general solicitation.
The withdrawal of this millstone around the neck of the Regulation D
market would give great confidence to market participants, and the
Commission should take such action ASAP!
In the meantime, I understand the concern of those who are choosing to
forego general solicitation until the Regulation D proposal has been
resolved, but I can say it would be an absurd, if not illegal, result for any of
the proposed Regulation D amendments to be applied retroactively to
ongoing offerings.
Also, apart from new 506(c), we have not changed the fundamental
framework of Regulation D since it was initially adopted in 1982.
Given the substantial changes in technology and the markets since then —
think Commodore VIC-20 to the Apple watch — it may be time to see if
there are other ways to balance access to capital and investor protection,
giving issuers other choices when raising capital.
For example, David Burton at the Heritage Foundation is advancing a
“micro offering” safe harbor, which would deem certain extremely small or
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limited offerings as not involving a public offering under Section 4(a)(2) of
the Securities Act.
These are the types of ideas we should be exploring.
In doing so, I believe it would be constructive to start from a point of
reference of the needs of real companies, and then figure out how to make
the securities laws fit those ends.
Imagine that!
For example, when I was meeting with start-ups and small businesses in
San Diego earlier this year, as part of my listening tour, a pair of young
entrepreneurs running a winery noted their frustration with meeting
fundraising goals.
They knew that, if they could just post their offer on Craigslist, they’d be
able to readily connect with investors, and spend their time growing their
company rather than fundraising.
I know the very thought of having a securities offering on Craigslist just
made some people’s heads explode.
But that highlights the divide between the real needs of real entrepreneurs
and the unfortunate reality of securities regulation today.
We need to find a reasonable way to bridge this gap.
III. Other Capital Formation Issues
For somewhat larger companies, I believe our rules aren’t fundamentally
flawed, but there are certainly some improvements that can be made.
Some take the view that companies have to be perfectly seasoned before we
can expose any unaccredited investor to the risk of investing in them.
In this view, companies that are not up to the standard of the largest issuers
should be kept out of our most liquid markets.
What is unanswered, of course, is how those companies will get the capital
they need to graduate to the “big leagues.”
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Or why ordinary investors should be limited to investing in blue chips,
rather than taking a chance on a young upstart.
I take a different view: investors are smart. They just have to have the
information they need to understand what they’re getting into.
If you want to go to the NYSE and buy GE, that’s fine; if you want to go to a
venture exchange and purchase shares in the latest Silicon Valley app
maker, that’s fine too.
It’s impossible for these smaller start-ups to comply with the reporting
expected of the largest companies, though, so I’ve previously advanced a
few ideas that I think could help.
For example, we should further segment our small companies into bands
based on commonly-used market definitions of “nanocap” and “microcap,”
and more radically scale reporting requirements for the smallest issuers.
Unfortunately, our recent rules do not inspire confidence that the
Commission can resist slapping small companies with immaterial reporting
requirements.
A majority of the Commission decided to apply our extraordinarily
burdensome conflict minerals rule to smaller companies, with an
oh-so-generous 2 year phase-in.
And, we just proposed hedging disclosure requirements that, over my
protest, would apply to smaller reporting and emerging growth companies.
The only time the Commission seems willing to exempt SRCs and EGCs has
been when Congress explicitly says to do so — and even then, it’s
begrudgingly done.
My skepticism notwithstanding, I hope and expect that the Division of
Corporation Finance will come out with an aggressive agenda for disclosure
simplification as a result of its much-discussed study of disclosure
requirements.
If that study simply affirms our existing disclosure regime, when there has
been over a decade of unfinished efforts aimed at streamlining disclosures,
it will have been a failure.
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The difficulty, of course, is that every piece of disclosure in our rulebook
will have some constituency who will cry loudly when their ox gets gored.
But we need to take a hard look at whether the benefits that some assert
exist are worth the burden placed on all shareholders — and eliminate or at
least reduce the burden when it is not.
On the flip side, we’ve already seen partisans for added disclosure —
particularly sustainability or integrated disclosure — make their case for
inclusion in this project.
Companies are free to make these disclosures voluntarily.
But I am absolutely opposed to broadening our already-burdensome
disclosure requirements to include these non-material issues.
In the meantime, I hope the SEC can do a more rigorous cost-benefit
analysis of its new rules, including an analysis of the total burden of
regulations.
We have deep and liquid capital markets, and the SEC makes it relatively
straightforward for issuers to access them, but we’re steadily attaching
more and more strings.
It’s only a matter of time before, like Gulliver tied to the ground by the
Lilliputians, companies that have the misfortune to be public issuers will be
unable to move, to innovate, to create.
And all investors will be harmed for it.
IV. Conclusion
Unfortunately, despite having passed Regulation A+, the Commission does
not merit a grade of A+ in its attention to capital formation issues.
At best, our grade is “incomplete” given the significant number of critical
investor protection issues that need to be taken up in the near future.
Yes, that’s right — capital formation and investor protections walk
hand-in-hand.
Rulemaking derided as “deregulatory” may nonetheless help investors, if
the costs of that disclosure, both direct, in terms of dollars diverted to
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compliance, and indirect, in terms of the opportunity costs of those dollars,
are not outweighed by the benefits.
I believe our rulebook is full of such rules, and hope we can take them on,
and soon.
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Remarks of Secretary Lew Before Meeting
with Chinese Vice Premier Wang Yang
Thank you, Vice Premier Wang, for your hospitality
in hosting me here today.
Vice Premier Wang and I have become friends as we have worked together
over the past two years to deepen our economic cooperation and ensure this
relationship is one that benefits citizens of both of our countries.
It is in this spirit that we look ahead to this summer’s meeting of the
Strategic and Economic Dialogue, where we will work to make progress on
the issues that matter most to us.
Our goal is to continue to make concrete and tangible progress on our
respective issues of concern in order to deliver mutual benefits to the
United States and China.
Promoting innovation and open markets is in our mutual interest.
We have already made clear our concerns regarding forced technology
transfer and other attempts to bar technological competition, most recently
in the banking sector, and I look forward to further discussion today.
We must continue our discussions about sustaining growth going forward,
both in our countries and the global economy.
We must work to achieve a mutually beneficial bilateral economic
relationship, including through a trade and investment relationship that
provides a level playing field and supports jobs and growth.
In addition, it is critical that China continue to move to a more
market-determined exchange rate and a more transparent exchange rate
policy.
We support China’s efforts to shift towards greater reliance on domestic
demand.
And we look forward to working with China as it continues to deepen its
financial reforms and becomes more integrated into and assumes greater
responsibility in the global financial system.
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I look forward to another set of candid and productive discussions on our
shared interests and challenges, and to hosting you and your delegation in
Washington in a few short months.
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Economic and monetary
developments
Overview
Part A
With a view to pursuing the ECB’s price stability mandate, the Governing
Council has taken a number of monetary policy measures to provide a
sufficient degree of monetary policy accommodation.
Following the monetary policy initiatives taken by the ECB between June
and September 2014, which included further interest rate cuts, the
introduction of targeted longer-term refinancing operations (TLTROs) and
purchases of selected private sector assets (under the asset-backed
securities purchase programme (ABSPP) and the third covered bond
purchase programme (CBPP3)), the Governing Council decided in January
2015 to expand its asset purchase programme (APP) to encompass, as of
March, euro-denominated investment-grade securities issued by euro area
governments and agencies and European institutions.
The combined monthly purchases of public and private sector securities
will amount to €60 billion.
They are intended to be carried out until end-September 2016 and will in
any case be conducted until the Governing Council sees a sustained
adjustment in the path of inflation which is consistent with its aim of
achieving inflation rates below, but close to, 2% over the medium term.
The asset purchase programme has already roduced a substantial easing of
broad financial conditions.
In December 2014 and most of January 2015 financial market
developments were to a large extent driven by market expectations
regarding the announcement of the APP.
In this context, euro area bond yields declined across instruments,
maturities and issuers and in many cases reached new historical lows.
Since the declines in yields on AAA-rated long-term euro area sovereign
bonds coincided with increases in equivalent US bond yields, the
decoupling of euro area and US government bond yields continued.
Yields on lower-rated euro area sovereign bonds also fell, but were more
volatile amid uncertainty about Greece’s continued access to financial
assistance. Spreads on investment-grade corporate bonds continued their
decline, while ABS spreads remained broadly stable.
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Following the APP announcement, euro area bond yields fell further, while
stock prices in the euro area increased considerably.
The euro’s exchange rate has weakened significantly over recent months.
Favourable developments in financial markets have led to lower bank
funding costs, which have gradually been passed on to the cost of external
finance for the private sector.
TheECB’smonetarypolicymeasureshaveresultedinanimprovementinbankfi
nancingconditions, with yields on unsecured bank bonds declining to
historical lows in the fourth quarter of 2014.
This improvement has been gradually passed through to bank lending rates
for households and non-financial corporations (NFCs), which in the third
and fourth quarters of 2014 fell substantially.
The reduction in bank funding costs and in bank lending rates in the second
half of 2014 can be partly attributed to the TLTROs, which are designed to
improve banks’ access to longer-term liquidity and stimulate credit growth
in the real economy.
The TLTROs should also have helped narrow margins on loans to euro area
households and NFCs.
In order to underpin the effectiveness of the TLTROs in supporting lending
to the private sector, the Governing Council decided at its January meeting
that the interest rate for the remaining TLTROs would be equal to the rate
on the Eurosystem’s main refinancing operations, thus removing the 10
basis point spread over the MRO rate that applied to the first two TLTROs.
The ECB’s monetary policy measures appear to have also promoted a
narrowing of the cross-country dispersion of borrowing costs, especially for
NFCs, although credit conditions remain heterogeneous across countries.
The nominal cost of non-bank external finance for euro area NFCs
continued to decrease in the fourth quarter of 2014 and in the first two
months of 2015, as a result of a further decline in both the cost of
market-based debt and the cost of equity.
Recent data also indicate a firming of money and credit dynamics.
Annual growth in the broad monetary aggregate M3 is still supported by its
most liquid components, with the narrow monetary aggregate M1 growing
robustly.
Bank lending to the private sector has continued to recover, confirming the
occurrence of a turnaround in loan dynamics at the beginning of 2014.
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In particular, the decline in loans to NFCs has continued to moderate over
recent months, while the growth of loans to households has stabilised at
positive levels.
Moreover, the January 2015 euro area bank lending survey confirmed the
assessment that credit supply constraints were gradually receding and
demand for loans was recovering.
Overall, recent developments suggest that the ECB’s monetary policy
measures are contributing to an easing of bank lending conditions and,
more generally, to restoring the proper functioning of the monetary policy
transmission mechanism.
The substantial additional easing of the ECB’s monetary policy stance
supports and reinforces the emergence of more favourable evelopments in
euro area economic activity.
The economic recovery firmed gradually in the second half of 2014. Real
GDP increased by 0.2%, quarter on quarter, in the third quarter of the year,
and, according to Eurostat’s flash estimate, by 0.3% in the fourth quarter,
which was somewhat higher than previously expected.
Short-term indicators and survey results point to a further improvement in
economic activity at the beginning of 2015.
It appears that euro area activity has been supported by the significant fall
in oil prices since July 2014.
An environment of improving business and consumer sentiment will
support the effective transmission of the policy measures to the real
economy, contributing to a further improvement in the outlook for
economic growth and a reduction in economic slack.
The economic recovery is expected to strengthen and broaden gradually.
Growth in activity is expected to increase on account of the recent
improvements in business and consumer confidence, the sharp fall in oil
prices, the weakening of the effective exchange rate of the euro and the
impact of the ECB’s recent monetary policy measures.
The accommodative monetary policy stance – substantially reinforced by
the APP – is expected to support real GDP growth in both the short term
and beyond.
Furthermore, the progress made in structural reforms and fiscal
consolidation should gradually benefit the real economy.
Exports should be supported by gains in price competitiveness and the
global recovery.
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At the same time, several obstacles to a stronger pick-up in activity persist.
These include primarily the ongoing balance sheet adjustments in various
sectors and the rather slow pace at which structural reforms are being
implemented.
In addition, diminishing but ongoing uncertainty related to the European
sovereign debt crisis and geopolitical factors are dampening growth in the
euro area.
The March 2015 ECB staff macroeconomic projections for the euro area,
which incorporate the estimated impact of both standard and non-standard
monetary policy measures taken by the Governing Council, foresee annual
real GDP increasing by 1.5% in 2015, 1.9% in 2016 and 2.1% in 2017.
Compared
with the December 2014 Eurosystem staff macroeconomic projections, the
forecasts for real GDP growth in 2015 and 2016 have been revised upwards,
reflecting the favourable impact of lower oil prices, a weaker effective
exchange rate of the euro and the impact of the recent monetary policy
measures.
In the Governing Council’s assessment, risks to the outlook for activity
remain on the downside, although they have diminished following the
Governing Council’s latest decisions and the fall in oil prices.
On the basis of current information, inflation is expected to remain very low
or negative over the coming months.
Oil prices are a major factor behind HICP inflation having turned negative
in recent months.
According to Eurostat’s flash estimate, annual HICP inflation was -0.3% in
February 2015 (up from -0.6% in January).
At the same time, HICP inflation excluding energy and food continued on a
broadly stable path, remaining at 0.6% in February.
Inflation rates are expected to gradually rise later this year.
First, as past declines in energy prices will gradually drop out of the annual
rate of change and provided oil prices increase over the projection horizon
in line with the upward-sloping oil futures curve, the negative impact from
energy prices on headline HICP should fade in 2015 and energy prices
should increase headline inflation in 2016 and 2017.
The expected pick-up in overall inflation is to a large part driven by this
turnaround in energy prices.
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In addition, the increase in overall inflation should follow from the firming
economic recovery, which is supported by the recent monetary policy
decisions.
The firming recovery is expected to result in a significant narrowing of the
negative output gap and thus stronger growth of profit margins and
compensation per employee.
The increase in inflation should also be supported by rising non-energy
commodity prices and the lagged effects of the weaker exchange rate of the
euro.
The March 2015 ECB staff macroeconomic projections for the euro area
foresee annual HICP inflation at 0.0% in 2015, 1.5% in 2016 and 1.8% in
2017.
Compared with the December 2014 Eurosystem staff macroeconomic
projections, the forecast for inflation in 2015 has been revised down, mainly
reflecting the fall in oil prices, while the projection for 2016 has been
revised up, partly reflecting the expected impact of the monetary policy
measures.
The March 2015 ECB staff macroeconomic projections are conditional on
the full implementation of the ECB’s monetary policy measures.
The Governing Council will continue to closely monitor the risks to the
outlook for price developments over the medium term, focusing, in
particular, on the pass-through of the monetary policy measures,
geopolitical developments, and exchange rate and energy price
developments.
The current focus of monetary policy is on implementation of the measures
decided by the Governing Council in January 2015.
Based on its regular economic and monetary analyses, and in line with its
forward guidance, the Governing Council decided at its meeting on 5 March
2015 tο keep the ECB interest rates unchanged.
It also provided further information on aspects of the implementation of
the APP.
Purchases of public sector securities in the secondary market under this
programme started on 9 March 2015.
1.
External environment
Global growth is recovering gradually, albeit unevenly, across economies.
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On the one hand, the significant fall in oil prices is expected to boost global
activity, supported by a robust outlook for growth in the United States.
On the other hand, the deteriorating situation in some emerging market
economies is weighing on the outlook for global growth.
Global inflation has moderated in recent months.
Annual rates of inflation are likely to remain low in the near term in view
of the past decline in oil prices and to rise only gradually thereafter as the
global recovery continues.
Risks to global activity remain on the downside.
The global economy is continuing along a path to gradual recovery.
Following the pick-up in global growth in mid-2014, available country data
point to a slight softening in global growth outside the euro area towards
the end of the year.
Latest surveys indicate a stable growth momentum in early 2015.
The global composite output Purchasing Managers’ Index (PMI) excluding
the euro area edged up in February, although divergences across regions
remain (see Chart 1).
Lower oil prices are expected to boost global demand.
Brent crude oil prices declined sharply in December and January, before
rebounding somewhat in February to stand at USD 61 on 4 March 2015,
almost half the level of one year ago (see Chart 2).
According to the futures curve, markets have priced in a gradual increase in
oil prices for the coming years.
While part of the decline in oil prices over the past year can be attributed to
relatively subdued global demand, it is mainly due to increased supply.
Abundant supply from North American shale oil, higher than expected
production in Russia, Libya and Iraq, despite geopolitical tensions,
combined with the decision of OPEC not to cut production at the November
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2014 meeting, have all contributed to a reassessment of supply-demand
dynamics by market participants and a sharp drop in oil prices.
Lower oil prices are expected to benefit net oil-consuming countries, while
weighing on prospects for oil exporters.
On balance, however, it is likely that they will support global demand, as
oil-importing countries, which benefit from the price decline, tend to have a
higher propensity to spend than oil-exporting countries.
Robust growth in the United States is also supporting the global outlook.
Activity remained strong in the last quarter of 2014, led by personal
consumption and residential investment.
The labour market also continued to improve, with employment expanding
at a vigorous rate.
Looking ahead although the appreciation of the US dollar will temper
export growth, a sustained upturn in domestic demand is expected,
supported by continued accommodative financial conditions and a
moderating fiscal drag.
Waning household deleveraging, continued improvements in the labour
and housing markets, and the boost to real incomes from lower oil prices
are expected to support private consumption.
Improved confidence, stronger demand and low interest rates are likely to
spur business investment, offsetting lower capital expenditure in shale oil
industries.
The growth momentum in most other advanced economies outside the euro
area has also firmed up.
In Japan, after the slump in activity following the VAT hike in April last
year, growth resumed in the fourth quarter of 2014.
Looking ahead the underlying drivers of growth are expected to strengthen
slowly, benefiting from the gains in household real incomes provided by the
lower oil price, the boost to export growth from the recent depreciation of
the Japanese yen and lower fiscal drag following the government
announcement that additional stimulus would take place in the next fiscal
year.
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Despite some softening in the fourth quarter of 2014, the UK economy is
also continuing to expand at a relatively robust pace.
Looking ahead although continued fiscal consolidation efforts are expected
to dampen growth, falling energy prices and accelerating wage growth
should support real disposable incomes and private consumption.
In addition, the recovery in demand and easing of credit conditions should
spur business investment.
At the same time the abrupt appreciation of the Swiss franc following the
decision in January by the Swiss National Bank to abandon the cap on the
Swiss franc/euro exchange rate is expected to have a significant adverse
impact on the country’s economic outlook, chiefly through lower exports.
Near-term prospects have improved in some emerging market economies,
particularly in oilimporting countries.
In China, while the housing market slowdown weighed on growth in the
fourth quarter of 2014, the decline in oil prices, continued robust
consumption, recent monetary easing and modest fiscal stimulus are
expected to provide some temporary support for the economy.
However, the Chinese political leadership has placed increasing emphasis
on tackling financial fragilities and macroeconomic imbalances in a
longer-term perspective.
As the economy moves towards a more sustainable path, growth is likely to
moderate.
Lower growth in China will have knock-on effects on those Asian economies
with which it has close economic and financial links, but many countries in
emerging Asia should benefit in the short term from the boost from lower
oil prices to real disposable incomes.
In particular, confidence remains high in India amid signs that the growth
momentum is improving.
As an oil-importing country, it will benefit from the lower oil prices, which
help to contain both inflation and the current account deficit, while
allowing the government to cut fuel subsidies and support fiscal
consolidation.
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Central and eastern European countries are also expected to benefit from
strengthening domestic demand, as improved labour market dynamics and
the recent decline in oil prices are expected to support household
consumption.
Elsewhere, the outlook is for weaker activity.
In Latin America, medium-term prospects appear to be weaker than
previously expected following a period of disappointing growth outturns, as
growth has been dampened by supply-side bottlenecks and high domestic
imbalances in some key economies (see Chart 3).
Lower oil prices are also weighing on the prospects of oil exporters.
In particular, in Russia, the recent turmoil in financial markets is expected
to push the economy into recession in 2015.
The sharp depreciation of the rouble and monetary tightening will mean a
sizeable increase in financing costs, potentially exacerbating funding
problems for firms already facing sanctions that restrict their access to
external financial markets.
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It is expected that household consumption will be affected by high inflation,
which weighs on real disposable incomes.
With business confidence depressed and uncertainty remaining high,
investment is expected to fall. In the medium term, lower energy prices will
potentially undermine investment in the exploration of oil and gas deposits.
These developments are anticipated to have a negative impact on euro area
foreign demand.
Global trade lost some momentum towards the end of 2014 and is expected
to recover only gradually.
The volume of world merchandise imports increased by 1.3% on a
three-month-onthree-month basis in December.
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Having declined in previous months, the global PMI new export order
index recovered in December 2014 and stabilised in January 2015,
suggesting more resilience in global trade at the turn of the year.
Looking further ahead world trade is expected to strengthen at a very
moderate pace.
In recent years cyclical weakness in business investment, which typically
has a high import content, has restrained the pace of global trade.
At the same time, structural factors have affected global trade, as firms have
reduced the complexity and length of their supply chains, which means that
the expansion of global value chains is no longer supporting global trade
growth to the same degree as in the past.
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As a result, although global trade is expected to pick up as cyclical weakness
unwinds and global investment recovers, it is unlikely to expand at the
same pace as in the 1990s and 2000s, when large emerging market
economies were integrating into the global economy, greatly expanding
global trading opportunities.
Overall, the global recovery is expected to pick up gradually.
According to the March 2015 ECB staff macroeconomic projections, world
real GDP growth (excluding the euro area) is expected to rise from 3.6% in
2014 to around 4% in 2016 and 2017.1 Euro area foreign demand is
expected to increase from 2.8% in 2014 to 5.1% by 2017.
Compared with the December 2014 projections, expectations for global
growth and foreign demand have hardly been revised.
This outlook reflects the expectation that the boost to global demand from
the fall in oil prices will be broadly outweighed by less favourable prospects
in some emerging market economies.
Risks to the outlook for global activity remain tilted to the downside.
While the impact of lower oil prices on the global outlook for growth might
be stronger than that embedded in the March 2015 ECB staff
macroeconomic projections, in the United States, markets continue to
expect the pace of interest rate increases to be slower than envisaged in the
latest FOMC projections.
As discussed in Box 1, inflationary pressures in the United States are
expected to remain limited.
However, there is uncertainty regarding the degree of slack in the economy
and the extent to which higher demand will lead to higher wage and
inflation pressures.
A faster normalisation of monetary policies than currently expected by
markets could trigger a reversal of risk sentiment.
In China, high credit growth and leverage pose risks to financial stability.
Geopolitical risks also continue to weigh on the outlook, and a scenario in
which tensions between Russia and Ukraine re-escalate would have adverse
implications for global growth.
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Global inflation has fallen in recent months, driven mostly by declining
energy prices.
Annual consumer price inflation in OECD countries decreased to 0.5% in
January 2015. At the same time annual inflation excluding food and energy
has remained more stable (see Chart 4).
Outside the OECD countries, inflation in China has also moderated in
recent months, as broad disinflationary pressures persist.
However, in other large emerging market economies, inflation has
increased where currency depreciation has led to higher import prices or a
lack of credibility in domestic monetary policy has been reflected in
continued high inflation expectations.
Global inflation is expected to remain low in the short term and to rise only
gradually thereafter.
Ongoing weakness in commodity prices is expected to contribute to low
global inflation in the short term.
Thereafter the projected pick-up in world economic activity is expected to
diminish spare capacity.
In addition, the oil price futures curve implies some recovery over the
coming years, as do futures prices for non-oil commodities.
2.
Financial Developments
In December 2014 and most of January 2015 financial developments were
driven largely by market expectations about the expanded asset purchase
programme (APP) which was announced after the meeting of the ECB
Governing Council on 22 January 2015.
Before the APP announcement, euro area bond yields declined across
instruments, maturities and issuers and reached new historic lows in
many cases.
Yields on AAA-rated long-term euro area government bonds declined
while equivalent US bond yields increased, so that the spread between the
two widened further.
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Yields on lower-rated euro area government bonds also declined but they
displayed greater volatility, linked to the uncertainty surrounding
Greece’s continued access to financial assistance.
Following the announcement of the APP and in February and March, euro
area government bond yields continued to decline.
Furthermore, stock prices in the euro area increased significantly.
The euro weakened substantially.
The EONIA decreased between early December 2014 and early March 2015
amid higher levels of excess liquidity.
It averaged -0.04% over that period, about 3 basis points lower than the
average for the previous three months.
Box 2 looks at liquidity conditions and monetary policy operations in
greater detail.
The announcement of the APP – and the expectations preceding it –
resulted in EONIA forward rates declining significantly.
From early December 2014 to early March 2015 the EONIA forward curve
thus became more inverted, bottoming out at a level of -0.15% for the first
eight months of 2016, which is close to the current deposit facility rate of
-0.20% (see Chart 5).
These developments are consistent with market participants expecting a
significant but gradual increase in excess liquidity as a result of the APP
announcement.
In comparison with early December 2014, in early March 2015 the point at
which markets expected the EONIA to return to positive levels moved back
by 7 months, from July 2017 to February 2018.
A broadly similar development was recorded for the future path of the
threemonth Euribor.
Yields on AAA-rated euro area government bonds also declined owing to
expectations relating to the APP announcement (see Chart 6).
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However, being directly affected by the APP – and also benefiting from
reductions in liquidity risk premia – yields on longer-term AAA-rated
government bonds declined slightly more strongly than EONIA swap rates.
As a result, yields on 10- and 30-year AAA-rated government bonds
declined between early December and early March by about 50 basis points,
standing at 0.4% and 1.1% respectively on 4 March.
Yields on shorter-term bonds, such as AAA-rated two-year government
bonds, also declined, moving into negative territory in some countries.
Yields on lower-rated euro area government bonds (except Greek bonds)
also declined, but displayed greater volatility.
From early December 2014 to early March 2015, declines in yields tended to
be stronger for lower-rated government bonds than for higher-rated ones,
partially reflecting an increased “search for yield” in response to low – and
falling – yields.
Although the increased uncertainty surrounding Greece’s continued access
to finance exerted some upward pressure on the yields of lower-rated euro
area government bonds (see Chart 7), the new agreement reached in the
Eurogroup in late February 2015 generally helped to contain this upward
pressure.
In particular, the spreads between the yields of ten-year Greek and German
government bonds increased by around 250 basis points between early
December 2014 and early March 2015, while the equivalent spreads
between German government bonds and those of other euro area countries
either remained stable or declined.
Uncertainty in the euro area government bond market increased somewhat,
as indicated by a slight rise in option-implied volatility.
This may reflect uncertainty surrounding Greece’s continued access to
finance, as well as some uncertainty regarding the specific details of the
APP’s implementation.
The decoupling of euro area and US government bond yields continued.
The spread between US and euro area AAA-rated bond yields increased
between early December 2014 and early March 2015, standing at around
180 basis points at the beginning of March.
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This spread started to increase in mid-2013 and since then the decoupling
trend has continued, with the spread recently reaching the widest point on
record since the data series began in September 2004.
This divergence in yields is consistent with the growing market perception
that the two economies are in different cyclical positions and with market
expectations about future monetary policy in the two areas.
Spreads on investment-grade corporate bonds continued to decline.
Corporate bond spreads – for both financial and non-financial issuers –
declined further over the past few months (see Chart 8) and thus remained
low, close to the levels observed prior to the onset of the financial crisis.
This was probably fuelled by expectations that the APP would result in
portfolio-rebalancing effects and, in connection with that, an increased
search for yield.
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Moreover, the APP can be expected to further reduce the cost of finance and
increase corporate evenue, thereby reducing the perceived probability of
default on corporate bonds.
Spreads for financial issuers declined more than spreads for non-financial
issuers, possibly reflecting market sentiment on progress made with the
ongoing re-capitalisation of financial institutions in the euro area (see also
Section 5 on money and credit).
Spreads on asset-backed securities remained broadly stable.
Stock prices in the euro area increased significantly.
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From early December 2014 to early March 2015 they increased by around
13.0%, thereby outperforming stock markets in both the United States and
Japan (see Chart 9).
Most of the gains in the euro area were recorded immediately after the
announcement of the APP (which led to a decline in the expected future
cost of financing, and thus had a positive effect on the discounted value of
expected future corporate earnings).
In late February the fact that the Eurogroup agreed to extend Greece’s
financial assistance programme also helped to increase the appetite for risk.
However, the price-to-book value ratios of euro area stocks remain below
the levels observed prior to the financial crisis, suggesting that investors
continue to have somewhat subdued expectations regarding future
corporate earnings and/or that they still require a relatively high level of
compensation for the risk of investing in equity.
This is particularly true of financial shares, the prices of which remain well
below the peaks observed prior to the financial crisis.
Stock market uncertainty, as measured by implied volatility, increased
marginally in both the euro area and the United States over the review
period.
Stock price increases were stronger in the non-financial sector than in the
financial sector.
The prices of financial shares rose by around 10% from early December to
early March, while those of non-financial shares increased by slightly more
than 14%.
The relative weakness of the financial sector was concentrated in the period
before the APP announcement, while prices in the two sectors moved
broadly in parallel thereafter (see Chart 10).
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The effective exchange rate of the euro weakened further over the past few
months.
The weakening of the euro, which had begun back in May 2014, continued,
notably in the run-up to the Governing Council’s January 2015 meeting,
reflecting market expectations of impending monetary policy decisions.
Overall, in early March the effective exchange rate of the euro stood around
10% below the level recorded one year earlier.
Box 3 reviews recent movements in the effective exchange rate of the euro.
Regarding bilateral exchange rate developments, the euro declined by
around 10% against the US dollar between December 2014 and early March
2015.
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The euro also fell considerably against the Swiss franc following the Swiss
National Bank’s discontinuation of its minimum exchange rate target of
1.20 Swiss francs per euro in mid-January.
The Danish krone continued to trade close to its central rate within ERM II
during this period, while Danmarks Nationalbank intervened in foreign
exchange markets, and reduced the interest rate on certificates of deposit
five times.
Moreover, on 30 January the issuance of Danish government bonds was
suspended until further notice.
At the same time, the euro appreciated significantly against the Russian
rouble.
3.
Economic activity
The euro area economic recovery has shown a gradual firming since
mid-2014 and labour markets have improved.
Moreover, a number of factors have recently further supported euro area
activity.
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Lower oil prices are bolstering real disposable income, thus supporting
private consumption.
The recent depreciation of the euro exchange rate has facilitated exports.
The recently announced expanded asset purchase programme (APP)
should further contribute to easing financing conditions and enhancing
access to credit.
Looking forward, economic activity is, therefore, expected to continue to
strengthen during the course of 2015 and beyond, driven by both domestic
and external demand, although unemployment is expected to remain high.
Against this background, the March 2015 ECB staff macroeconomic
projections for the euro area foresee a stronger growth outlook compared
with the December 2014 Eurosystem staff macroeconomic projections.
Domestic demand strengthened in the second half of 2014.
Real GDP increased by 0.3%, quarter on quarter, in the fourth quarter, after
0.2% in the third quarter of 2014.
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As a consequence, following seven consecutive quarterly increases, real
GDP in the euro area returned, in the fourth quarter of 2014, to the level
seen in the first quarter of 2011, albeit almost 2% short of its level just
before the start of the crisis in 2008 (see Chart 13).
Moreover, the strength of the recovery remains uneven across euro area
countries.
Although no breakdown was available at the time of this Economic
Bulletin’s cut-off date, economic indicators and country data suggest that
domestic demand continued to contribute positively to growth in the fourth
quarter of 2014.
It also appears that net exports made a positive contribution, as exports are
benefiting from the depreciation of the euro.
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The basis for the ongoing economic recovery has strengthened visibly over
recent months.
First, the sharp fall in oil prices, which is largely supply-driven, contributes
to a substantial increase in real disposable income.
Second, domestic demand will further benefit from the accommodative
monetary policy stance, leading to ongoing improvements in financial
conditions, as well as from the easing of credit supply conditions.
Third, euro area activity is expected to be increasingly supported by the
gradual strengthening of external demand and the depreciation of the euro.
In addition, factors such as weak global demand and the private and public
balance sheet adjustments, which had contributed to the recent prolonged
years of very weak real GDP growth, are gradually reversing and exerting a
more positive influence on economic activity in the euro area.
Against this background, both consumer and business confidence are now
at levels which are significantly above those observed at the end of 2012.
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These positive developments are also reflected in the March 2015 ECB staff
macroeconomic projections for the euro area.
The economic recovery in the euro area is projected to strengthen gradually
over the next three years.
Positive contributions to growth are expected from domestic and foreign
demand.
The ECB’s recent monetary policy measures should support activity
significantly in the near and medium term through a variety of channels.
According to the March 2015 ECB staff macroeconomic projections for the
euro area, annual real GDP in the euro area is expected to increase by 1.5%
in 2015, 1.9% in 2016 and 2.1% in 2017 (see Chart 15).
Consumption growth gained momentum in the latter part of 2014.
Private consumption growth in 2014 benefited significantly from rising
growth in real disposable income, reflecting stronger wage and non-wage
income, less need for fiscal consolidation as well as falling energy prices.
Following quarterly growth of 0.5% in the third quarter of 2014, short-term
indicators point to a further relatively robust increase in the final quarter of
the year.
For instance, both retail trade and car registrations increased in the fourth
quarter at rates higher than in the previous quarter.
Looking forward, growth in private consumption expenditure is expected to
remain a key driver of the pick-up in activity.
Private consumption should continue to benefit from the favourable impact
of rising wage growth on the back of increasing employment.
In addition, the positive impact of the fall in energy prices on real
disposable income will continue to support private consumption.
However, parts of the gains from lower oil prices will be used for savings
initially, as indicated by the expected increase in the households’ savings
ratio (see Box 4).
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Survey data point to continued resilient developments in consumer
spending.
For instance, the European Commission’s indicator for euro area consumer
confidence, which provides a reasonably good steer on trend developments
in private consumption, improved markedly in January and February 2015,
reaching pre-crises levels (see Chart 16).
Investment spending remained subdued in the second half of 2014.
Gross fixed capital formation in the euro area declined in the third quarter
of 2014, on the back of a decline in construction investment, while
non-construction investment remained stable.
In the fourth quarter of 2014, total investment is likely to have increased
modestly in quarterly terms, reflecting a growing production of capital
goods, a marginal increase in capacity utilisation and a pick-up in
confidence levels in the capital goods sector.
Turning to construction investment, higher construction output, compared
with the third quarter, and improving, but still below-average, confidence
indicators suggest weak positive growth in the fourth quarter.
Business investment growth is expected to gain momentum in 2015.
The Economic Sentiment Indicator (ESI) improved in both January and
February to stand above the level of the previous quarter, thus signalling a
possible acceleration in investment momentum.
Broadly in line with past recoveries following financial crises, the current
pick-up in investment has been subdued, hampered by persisting factors,
such as impaired balance sheets, in many parts of the corporate sector and
the rather gradual unwinding uncertainty stemming from the crisis.
In the third quarter of 2014 investment remained almost 17% below its peak
in the first quarter of 2008, which led to a sharp decline in the
investment-to-GDP ratio (Chart 17).
Looking ahead, the recovery of business investment is expected to gain
momentum, benefiting from the strengthening in external and overall
domestic demand, the need to modernise the capital stock after several
years of subdued investment, the very favourable financing conditions, the
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weaker euro exchange rate and the gradual strengthening in profit
mark-ups.
As for construction investment, a moderate recovery is expected from 2015
onwards, supported by very low mortgage rates in most countries, easing
financing conditions, stronger household loans and increasing growth in
disposable income.
Also the lower need for housing market adjustments in some countries will
support residential investment over time.
Net exports are expected to make a modest positive contribution to GDP
growth, as exports are being supported by global demand and a weakening
of the exchange rate of the euro.
Euro area exports of goods and services rose by 1.3%, quarter on quarter, in
the third quarter of 2014.
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In the fourth quarter of 2014, exports to the United States, China and other
Asian economies continued to strengthen, while exports to European
countries outside of the euro area and to Latin America were subdued.
Euro area exports are expected to continue to grow in 2015 and beyond,
supported by a gradual strengthening of global demand and the
depreciation of the effective exchange rate of the euro.
Euro area imports are expected to continue to grow in early 2015 and to
further strengthen over the medium term in line with the recovery in
domestic demand.
As a result, net exports are expected to contribute only modestly to real
GDP growth over the projection horizon.
Some factors continue to hinder a stronger pick-up in overall activity.
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The ongoing balance sheet adjustments in various sectors will continue to
exert downward pressure on domestic demand.
In this respect, a persisting need for adjustments in housing markets, as
also reflected in the continuing fall in house prices in several countries, is
dampening residential construction in those euro area countries.
In addition, lingering, albeit diminishing, uncertainty surrounding the
European sovereign debt crisis and geopolitical factors will continue to
weigh on the recovery.
The extended period of weak growth experienced by the euro area in recent
years has been associated with the correction of macroeconomic
imbalances in a number of countries.
In this context, Box 5 examines the outcome of the 2015 review under the
Macroeconomic Imbalance Procedure.
Risks to the outlook for activity are on the downside, but have diminished
following recent monetary policy decisions and the fall in oil prices.
Downside risks to the outlook for economic activity include a further
increase in geopolitical tensions and renewed sovereign debt market
tensions in the euro area.
These downside risks are only partly offset by the upside risks relating to a
stronger than expected impact of structural reforms and of the EU
investment plans on activity.
The euro area labour market situation is gradually improving.
Headcount employment (see Chart 18) grew by 0.2%, quarter on quarter, in
the third quarter of 2014 (the latest period for which data are available),
thus marking the third consecutive quarter of growth.
These increases reflect ongoing growth in the services sectors (particularly
market-related) and more recent signs of a stabilisation in industry and
construction.
In the construction sector, the modest headcount growth observed in the
third quarter reflects the first positive quarter-on-quarter increase in
employment seen since the third quarter of 2007.
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At the country level, besides positive developments in the German labour
market, employment growth was, to a large extent, driven by improvements
in countries with currently high unemployment rates, such as Spain,
Portugal and Greece.
Total hours worked also increased, quarter on quarter, in the third quarter
of 2014, by 0.4%, again somewhat faster than the increases seen in previous
quarters, following the rebound from the latest euro area recession.
Although survey results are still at low levels, they nevertheless indicate a
continuing improvement in employment at the turn of the year.
Forward-looking indicators also point to some further improvements in
labour market conditions.
Unemployment continues to gradually recede from elevated levels.
The euro area unemployment rate stood at 11.2% in January 2015, already
0.6 percentage point lower compared with one year earlier, but still 1.3
percentage points above its lowest trough in April 2011 and 4.0 percentage
points above its pre-crisis trough.
However, ongoing declines in unemployment rates are now visible across
all groups (youth, adult, male and female) and across most euro area
economies, although substantial differences remain.
Looking ahead, euro area labour markets are expected to improve further
over the short and medium term.
While the recent rebound in employment growth has already been stronger
than would have been anticipated on the basis of historical relationships,
stronger employment growth is expected over the coming quarters, on the
back of a strengthening recovery, thus reflecting the positive impact of
structural reforms in countries adversely hit by the crisis.
As a consequence, the euro area unemployment rate is expected to decline
further as the recovery broadens.
4. Prices and costs
Global and domestic factors have accounted for the protracted fall in
HICP inflation since late 2011, with the recent sharp fall in oil prices
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having been the main driver behind inflation turning negative in recent
months.
On the basis of prevailing oil futures prices annual HICP inflation is
expected to remain at negative or very low levels over the coming months.
The March 2015 ECB staff macroeconomic projections for the euro area
expect inflation to average at 0.0% in 2015, but to rise significantly to 1.5%
in 2016 and further to 1.8% in 2017.
HICP inflation excluding energy and food is expected to rise from 0.8% in
2015 to 1.3% in 2016 and 1.7% in 2017.
The recent monetary policy measures are expected to contribute to the
increase in inflation over the projection horizon and to underpin the
anchoring of inflation expectations.
The risks to the outlook for price developments over the medium term will
be closely monitored, with a particular focus on the passthrough of the
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monetary policy measures and geopolitical developments, as well as
exchange rate and energy price developments.
Inflation outcomes in recent months have been significantly lower than
envisaged in the December 2014 Eurosystem staff macroeconomic
projections for the euro area.
According to Eurostat’s flash estimate, annual HICP inflation stood at
-0.3% in February 2015, after -0.6% in January and -0.2% in December
2014 (see Chart 19).
The lower than expected outcomes have been due mainly to lower
contributions from energy prices, as oil prices have declined sharply since
the mid-November cut-off date for the December 2014 projection exercise,
which took into account oil futures prices at the time (see Chart 2).
HICP inflation excluding energy and food has continued on a broadly stable
path.
The low level of underlying inflation can be attributed to a combination of
factors, including the lagged effects of the strong appreciation of the euro
until May 2014, the process of relative price adjustment in certain euro area
countries and the persistent weakness in consumer demand and pricing
power.
In addition, lower oil and other commodity prices have also exerted
downward pressure on HICP inflation excluding energy and food as lower
input costs have been passed through the price chain.
The direct effects of the decline in oil prices have dominated recent inflation
developments (see Chart 20).
The recent decline in oil prices is likely to have largely been passed through
to pre-tax prices for liquid fuels.
Other typical direct effects, for example via electricity and gas prices, have
also contributed to the recent negative inflation outcomes.
Food prices have also continued to come under downward pressure.
In recent months annual inflation rates for unprocessed food prices have
edged further into negative territory, while processed food price inflation
has moderated further.
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These developments partly reflect the indirect effects of the declines in
agricultural and other commodity prices through the production and price
chain.
The lagged impact of the appreciation of the euro until May 2014 and the
decline in international commodity prices is still weighing on prices for
non-energy industrial goods.
It should be noted that many of these items, such as computers and
electrical appliances, tend either to be imported or have a relatively high
import content.
In addition, the lower international oil prices may be exerting downward
pressure on prices for non-energy industrial goods, as energy is a major
cost factor in the production of such items.
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In addition to more cyclical factors, there may be more structural influences
on the inflation dynamics of these goods at work. Box 6 discusses the
potential inflation-dampening effects of e-commerce.
Pipeline pressures for non-energy industrial goods items remain subdued.
Producer price inflation for consumer goods, which tends to lead
non-energy industrial goods price inflation by around six to twelve months,
remained at a low level in January 2015.
In addition, survey data on input prices in the non-food retail sector
continued to fall in January 2015 (see Chart 21).
On the one hand, at the earlier stages of the price chain, the annual rate of
change in import prices for intermediate goods has been positive for the
second consecutive month as a result of the depreciation of the euro.
On the other hand, producer prices for intermediate goods, as well as prices
in euro for crude oil and other commodities, remain at subdued levels.
Muted labour cost developments have contained services price pressures.
As labour costs tend to constitute a relatively large share of overall costs in
the services sector, subdued wage growth has contributed to services price
inflation remaining at low but broadly stable levels (see Chart 22).
The weakness in wage growth and services price inflation can be attributed
to a number of factors.
It may to a large extent reflect the high amount of economic and labour
market slack in the euro area.
Moreover, the indirect effects of lower oil prices have also recently
contributed to a decline in the prices of transportation services, such as
aviation, where fuels are a major cost factor.
In addition, it may indicate higher wage and price flexibility in some euro
area countries as a result of structural reforms in labour and product
markets in recent years (see Chart 23).
The possibility of second-round effects from lower oil prices needs to be
monitored.
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On the one hand, greater wage flexibility would imply that any downward
adjustment may now be more pronounced.
On the other hand, a significant scaling-back of automatic wage indexation
may imply that any downward adjustment in wage growth is less
pronounced than may have previously been the case.
In addition, nominal wage rigidities still prevail in many countries, making
it more difficult to cut wages in absolute terms.
Survey-based measures of long-term inflation expectations suggest that
inflation will gradually return to levels close to 2% (see Chart 24).
Following the recent fall in oil prices, survey-based inflation expectations at
shorter maturities have declined substantially.
However, the decline in long-term survey-based inflation expectations has
been much less pronounced than that in market-based expectations.
In general, inflation expectations seem to have declined on account of low
inflation outcomes, amid declining oil and other commodity prices, as well
as weak growth.
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Market-based measures of inflation expectations have fallen further than
survey-based measures.
The relatively low level of market-based inflation expectations partly
reflects the influence of negative inflation risk premia.
A negative inflation risk premium means that inflation swap rates and
break-even inflation rates are lower than the future level of inflation
actually expected by market participants.
Such a situation can arise if market participants expect a scenario of lower
inflation to be more likely than a scenario of higher inflation.
As a result, market participants have a greater preference for holding
nominal bonds as opposed to inflation-linked assets, as the real return on
nominal bonds would be relatively favourable in such a scenario.
The declines in long-term market-based inflation expectations over recent
months have also been observed in the United States and the United
Kingdom (see Chart 25), and most likely reflect a global rise in negative
inflation risk premia.
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Looking ahead, HICP inflation is projected to average 0.0% in 2015, but to
rise significantly in 2016 and further in 2017.
On the basis of the information available in mid-February, the March 2015
ECB staff macroeconomic projections for the euro area expect headline
HICP inflation to increase from -0.4% in the first quarter of 2015 to 1.9% in
the final quarter of 2017, and to average 0.0% in 2015, 1.5% in 2016 and
1.8% in 2017 (see Chart 26).
The projected pick-up in overall HICP inflation reflects an expected
turnaround in energy prices, as indicated by the upward-sloping curve in oil
futures, the impact of the weaker effective exchange rate of the euro and a
significant strengthening in domestic cost pressures as the economy
recovers and the negative output gap rapidly narrows.
Improving labour markets and the decline in slack in the economy imply
greater domestic price pressures over the projection horizon.
Ongoing employment growth and declines in the unemployment rate are
projected to sustain a gradual increase in the growth of compensation per
employee, with the ongoing cost competitiveness adjustment processes in
some euro area countries hampering a stronger pick-up.
While growth in compensation per employee is picking up, the resulting
cyclical pick-up in productivity implies a flat profile for unit labour cost
growth over the next two years.
In 2017 the increase in growth in compensation per employee is projected
to slightly exceed that of productivity, given that in certain countries wages
are expected to catch up on account of the ongoing economic recovery
following years of wage restraint.
Following a decline in 2015 profit margins are expected to rise over the
remaining projection horizon as productivity picks up significantly and
economic activity strengthens.
Non-standard monetary policy measures are expected to contribute to the
increase in inflation over the projection horizon via both domestic and
external price pressures.
The favourable impact of the recent non-standard monetary policy
measures on real GDP growth and the resulting faster closing of the output
gap are expected to benefit growth in both profit margins and wages.
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The downward impact of these measures on the exchange rate of the euro
implies additional external price pressures via the exchange rate channel.
Moreover, favourable effects on confidence levels stemming from these
measures should help to stabilise inflation expectations.
The Governing Council of the ECB announced that it will closely monitor
the risks to the outlook for price developments over the medium term.
Particular attention will be paid to the pass-through of the monetary policy
measures and geopolitical developments, as well as exchange rate and
energy price developments.
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5. Money and credit
Annual growth in broad money (M3) recovered further, but remains at
subdued levels.
Meanwhile, annual loan growth picked up, confirming a turnaround in
loan dynamics at the beginning of 2014 – credit supply constraints are
abating gradually and the demand for loans is improving.
Overall, recent developments suggest that the ECB’s monetary policy
measures are helping to restore the proper functioning of the monetary
policy transmission mechanism and easing bank lending conditions.
In an environment of very low interest rates, money and loan dynamics
improved further.
Compared with the third quarter of 2014, monetary indicators point to
some positive developments.
These are also noticeable both in the supply of and demand for bank credit.
However, the growth of loans to euro area non-financial corporations
(NFCs) is still weak by historical standards and fragmentation in bank
lending rates remains pervasive throughout the euro area.
Recent data indicate a pick-up in underlying growth in M3, but it still
remains at subdued levels.
The annual growth rate of M3 increased to 2.9% in the fourth quarter of
2014 and to 4.1% in January 2015, up from 2.0% in the third quarter and a
trough of 0.8% in April 2014 (see Chart 27).
Annual growth in M3 continues to be supported by its most liquid
components, with the narrow monetary aggregate M1 growing robustly at
an annual rate of 6.7% in the fourth quarter of last year and at 9.0% in
January 2015 (compared with 5.7% in the third quarter).
Money-holders focus on overnight deposits.
The very low interest rate environment is still providing incentives for
money-holders to invest in overnight deposits within M3.
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M1 benefited from the elevated growth of overnight deposits held by both
households and NFCs (see Chart 28).
The money-holding sector’s preference for the most liquid assets, in
particular overnight deposits, points to a continued build-up of cash
buffers.
The low (and declining) levels of remuneration for less liquid monetary
assets contributed to the ongoing contraction of short-term deposits other
than overnight deposits.
Furthermore, the growth rate of marketable instruments (i.e. M3 minus
M2), which have a relatively small weight in M3, was less negative and
reached positive territory at the end of the fourth quarter of 2014.
In particular, holdings of short-term debt securities issued by monetary
financial institutions (MFIs) remained on a downward path until the fourth
quarter of
2014, but the annual growth rate became positive around the turn of the
year.
External transactions continue to support broad money growth.
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An assessment of the counterparts of M3 (see Chart 29) shows that its
dynamics were mainly driven by net external assets and by shifts away from
longer-term financial liabilities, while the turnaround in loan dynamics was
also a positive factor.
Relative to its peak in mid-2014, the contribution from the MFI sector’s net
external asset position moderated significantly in the fourth quarter of 2014
but remains positive, supported by the sizeable surplus in the current
account.
This moderation may reflect market expectations of lower future returns on
euro area assets, particularly among international investors.
Support also came from a further decline in the annual rate of change in
MFI longer-term financial liabilities (excluding capital and reserves) held
by the money-holding sector, which stood at -4.8% in the fourth quarter of
2014 and -5.7% in January 2015, compared with -3.4% in the third quarter.
Banks expanded their balance sheets in the fourth quarter of 2014 – for the
first time since mid-2012 (see Chart 30).
From end-2011 to April 2014 deleveraging by banks implied a reduction in
their total assets of around 6%.
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This deleveraging process led MFIs to decrease their lending activities
vis-à-vis the private sector.
It comes in response to a period of strong bank balance sheet expansion:
between 2005 and 2012, total assets of monetary financial institutions rose
significantly, reaching a peak of €33.7 trillion (i.e. 3.55 times euro area
GDP), which represents an increase of more than 60 percentage points of
GDP.
Adjustment processes remained a feature of the banking sector during the
fourth quarter of 2014.
As shown by the results of the ECB’s comprehensive assessment of euro
area banks (these were released in October 2014), banks have made
substantial efforts to strengthen their balance sheets.
Banks have improved their capital ratios partly through higher equity
issuance, but also through deleveraging and tighter lending conditions
(stricter credit standards, higher spreads on loans).
This emphasis on balance sheet adjustments and the marked recent
progress in bank capital ratios have helped set the conditions for a
sustained improvement in the bank lending channel of monetary policy.
Nevertheless, bank profitability remains weak, which may limit banks’
ability to extend lending should demand pick up more markedly and
weaken the pass-through of lower bank funding costs to bank lending rates.
Banks’ funding costs continued to improve in the fourth quarter of 2014.
The reduction in bank funding costs is related to the credit easing package
(targeted longer-term refinancing operations (TLTROs), the third covered
bond purchase programme (CBPP3) and the asset-backed securities
purchase programme (ABSPP)).
Favourable bank financing conditions are reflected in the yields on
unsecured bank bonds, which declined to historically low levels during the
fourth quarter of 2014 (see Chart 31), falling to an average of 0.69% in
January 2015.
Banks’ deposit costs decreased further, but there is, as yet, no sign of a
general movement into negative territory because of the ECB’s negative
deposit facility rate.
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Overall, the composite cost of bank funding keeps on declining against the
backdrop of net redemptions of MFI longer-term financial liabilities.
Subdued debt issuance activity may reflect supply-side developments as
banks consolidated their balance sheets and benefited from the ECB’s
TLTROs.
Furthermore, the January 2015 euro area bank lending survey (see survey
at: www.ecb.europa.eu/stats/money/surveys/lend/html/index.en.html)
showed that banks’ access to funding improved for all main market
instruments.
New issuance of debt securities benefited the most here, while bank
reported a marginal net tightening of their access to long-term deposits and
other retail funding instruments.
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Recent data confirm a turnaround in loan dynamics during the first quarter
of 2014.
The contraction in bank lending to the private sector moderated further.
Adjusted for sales and securitisation, the annual growth of MFI credit to the
private sector continued its recovery in the fourth quarter of last year
(standing at -0.3%, compared with -0.9% in the third quarter) and in
January (0.5%).
In particular, the decline in loans to NFCs has continued to moderate (see
Chart 32), while the growth of loans to households has stabilised at positive
levels (see Chart 33).
These developments have been supported by the significant decreases in
bank lending rates which have been observed in some parts of the euro area
since summer 2014, as well as by signs of an improvement in both the
supply of and demand for bank loans.
Although the subdued economic climate and historically tight lending
conditions still weigh on loan provision, recent editions of the euro area
bank lending survey confirm the assessment of gradually receding credit
supply tensions and point to rising demand for loans.
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Indeed, the January 2015 bank lending survey shows that increased
competition between banks contributed to an easing of credit conditions in
the fourth quarter of 2014, which coincided with a pick-up in firms’ loan
demand (see Chart 34).
Lower bank funding costs are gradually being passed on to bank lending
rates.
Since the second half of 2012, banks in all euro area countries have been
experiencing a progressive reduction in the cost of debt funding.
This positive development is related to the ECB’s standard and
non-standard measures aimed at a more accommodative monetary policy.
Although the improvement in banks’ funding costs has only slowly been
passed on to borrowers in the form of lower bank lending rates, there was
significant progress on this front in the second half of 2014 as the
composite costs of borrowing for households and non-financial
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corporations in all euro area countries declined by around 40 basis points
(see Charts 35 and 36).
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The overall growth in external financing of non-financial corporations in
the euro area strengthened somewhat by the end of 2014.
Securities issuance data for December 2014 confirm previous data
indicating that euro area NFCs’ issuance of debt and equity securities is
recovering from a weak third quarter.
The recovery in external financing was further supported by less negative
flows in terms of bank loans.
The nominal cost of non-bank external financing for euro area NFCs
declined further in the first two months of 2015 owing to the contraction in
the cost of market-based debt and the cost of equity, which, in turn, can be
mainly attributed to the expanded asset purchase programme (see Section
2).
Divergences in lending rates across countries have started to narrow.
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The credit easing package adopted in June 2014 appears to have promoted
a narrowing of the cross-country dispersion of borrowing costs.
Those euro area countries presently displaying weakness in loans to NFCs
have experienced particularly strong decreases in bank lending rates for
such loans.
The January 2015 bank lending survey also shows a further easing of terms
and conditions for new loans to NFCs, notably in the form of another
narrowing of margins on average loans (see Chart 37).
Furthermore, despite some very encouraging developments in credit supply
conditions for the euro area as a whole, credit standards remain
heterogeneous across countries and sectors.
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