By Elisabeth Roegele, Deputy President, Chief Executive Director of Securities Supervision / Asset Management, BaFin (Germany's Supervisory Authority)
The shock wave-like spread of COVID-19 at the beginning of the year led to an unprecedented shutdown of public and economic life, driven by the intention to contain the spreading of the virus and to prevent an overburdening of health-care systems. Economies, markets and consumers in many countries were affected, being more or less unprepared, impacting also the financial sector.
To limit negative effects on the economy in Europe, enormous financial aid packages have been put in place, both at national and European level, accompanied by adjustments in various legislative areas.
At the same time, BaFin, Germany’s Federal Financial Supervisory Authority, as well as its European and international counterparts, have implemented measures to help financial markets, market participants and consumers adjust to the quickly-changing situation in light of COVID-19 developments.
Market environment and challenges for regulators
The forecast for the global economy has worsened during the last months. [1] According to recent predictions by the International Monetary Fund (IMF), recovery will be more gradual than previously expected. [2]
More than half of the countries in the EU reacted to the pandemic by implementing stay-at-home orders or at least stay-at-home recommendations. [3] COVID-19 resulted in a significant contraction in the growth rate of the EU economy. [4]
Capital markets reacted strongly. Prices dropped massively following measures to limit the spreading of the virus. Short-selling positions went up and credit spreads significantly increased. [5] Subsequently, due to various regulatory, supervisory, central bank and fiscal measures taken, markets, in many cases, have rebounded. [6]
However, the underlying economic outlook is still far from stable. Significant challenges for the real economy still lie ahead. [7] As for many parts of the industry and many actors in capital markets, the developments of the past months pose challenges for supervisory authorities.
Easing regulatory requirements can have a calming effect on tight markets, but investor protection must not be compromised. [8] Measures by one authority are also often not enough. Since capital markets are interconnected and competition does not stop at national borders, continuing close cooperation between regulatory authorities in Europe and worldwide is indispensable to ensure fair competition and prevent market fragmentation.
Measures adopted must also strike a balance between conflicting individual and collective interests, as well as between short-term and long-term aspects, in order to prevent unintended incentives, moral hazards and negative long-term consequences.
BaFin’s actions at national level and in close cooperation with other organisations
BaFin has used its competences to support the operational and business continuity of institutions and the functioning of markets in the financial sector. In this regard, BaFin has used its discretion to provide market participants with relief from the pressure created by COVID-19 while at the same time being transparent and preserving consumer interests.
BaFin has suspended supervisory inspections, reduced requests for information, where possible without impact on data needs, and postponed regularly scheduled stress tests. External auditors were allowed to suspend on-site visits to supervised entities and conduct remote examinations instead. However, BaFin clarified on its website that remote examinations are allowed exceptionally only in the course of the official precautionary measures taken to fight the pandemic. The relevant statutory requirements remain valid and electronic access to relevant documents is an essential prerequisite. [9]
From the beginning of the crisis, BaFin has relied on a close dialogue with various important and highly affected market participants. The exchange of information has provided and continues to provide an up-to-date picture of the situation and is the basis for swift supervisory intervention where needed. BaFin has regularly requested updates vis-à-vis regulated investment firms that perform functions as a market maker or liquidity provider on trading venues on their implementation of emergency plan measures and information on the current state of liquidity.
Close oversight of asset management companies provided information on redemption rates and liquidity risk of their open-ended retail funds investing in financial instruments. Besides, BaFin called on asset managers, depositaries and credit institutions to accelerate proceedings to practically implement liquidity management tools such as swing pricing and redemption gates recently introduced by law. [10]
BaFin continued to update its COVID-19-related FAQs to answer enquiries from associations, institutions and investors. [11] Transparency is also key to preserve the necessary level of investor protection. In the given market environment, BaFin observes an increase in cases of possible misconduct to the detriment of consumers. One example is an increase in misleading stock promotions to consumers via different sources, advertising the investment in shares of companies professing, for example, to have the means to stop the spread of COVID-19. [12] Other examples include complaints about the behaviour of retail derivatives market makers, for example, for suspending of quotation or for quoting uncomprehensive prices for the products. [13]
Besides BaFin’s national measures, much work has been done in cooperation with European and international standard-setting bodies and supervisory authorities.
Supervisory authorities regularly exchanged information about their national market environment and measures taken via the International Organization of Securities Commissions (IOSCO) and the Financial Stability Board (FSB) to allow for a solid assessment of market situations and to prepare coordinated policy actions. [14]
Through IOSCO[15], regulators shared experiences in the context of COVID-19, for example, by providing case studies in the very important area of retail market conduct, which provide the basis for mutual learning and which will now be assessed and further worked upon to extract conclusions.
At European level, the European Securities and Markets Authority (ESMA), in close cooperation with the national supervisory authorities, has covered a variety of areas, such as the benchmark regulation, but also topics related to MIFID II/MIFIR. The instruments ranged from public statements to the temporary lowering of reporting obligations for net short positions in shares traded on a regulated market in the EU from 0.2% to 0.1%. [16] The ESMA website provides a comprehensive list of the measures taken. [17]
Outlook: Policies need to be adapted to the evolution of the pandemic and the course of economic recovery
Although financial markets have recovered from heavy devaluations in spring, COVID-19 still exists. Authorities around the world are called upon to remain vigilant, quickly identify adverse developments and react, using the full scope of their mandates, where needed.
Policy measures may also require adjustment. Where experience has shown a need for adjustment or where circumstances change, such as liquidity stress turning into solvency risk in the real economy and should liquidity risk increase in the financial sector, adjustments need to be assessed at short notice.
A close look must remain on consumer protection at all times, which may be endangered in particular if markets are in distress.
Regulators and supervisors can benefit from shared experiences and lessons learned, as well as from the results of policy effectiveness assessments as conducted by the Financial Stability Board.
At the latest, once an economic recovery has been firmly established, the question of when and how to exit temporary support measures will need to be addressed.
A gradual return to normality must eventually be envisaged. As challenging as the COVID-19 pandemic has been, and continues to be also for capital markets, deregulation is not the right consequence to promote sustainability, orderly markets and investor protection. Indeed, the regulatory reforms implemented since the financial crisis of 2008 have increased the system’s resilience and must not be rolled back.
[1] https://www.kfw.de/KfW-Group/KfW-Research/Themenseite-Konjunktur.html.
[2] https://www.imf.org/en/News/Articles/2020/07/10/sp071020-speech-on-the-global-and-asia-economic-outlook.
[3] https://www.ecdc.europa.eu/sites/default/files/documents/covid-19-rapid-risk-assessment-coronavirus-disease-2019-eighth-update-8-april-2020.pdf Seite 13.
[4] https://ec.europa.eu/commission/presscorner/detail/en/ip_20_1269.
[5] ESMA COVID-19 financial market impact Up-date No. 9, 15 April 2020.
[6] https://www.imf.org/en/Publications/GFSR/Issues/2020/06/25/global-financial-stability-report-june-2020-update.
[7] https://www.imf.org/en/Publications/GFSR/Issues/2020/06/25/global-financial-stability-report-june-2020-update.
[8] https://www.bafin.de/SharedDocs/Veroeffentlichungen/EN/Fachartikel/2020/fa_bj_2004_Corona_Hufeld_en.html.
[9] https://www.bafin.de/SharedDocs/Veroeffentlichungen/DE/Meldung/2020/meldung_2020_03_18_corona_virus4_VorOrtPruefungen.html.
[10] Börsen Zeitung of 17 April 2020 (available in German only) (https://www.boersen-zeitung.de/index.php?li=1&artid=2020074001&titel=BaFin-verlangt-neue-Liquiditaetsregeln-fuer-Fonds).
[11] BaFin FAQs available on BaFin’s website: https://www.bafin.de/EN/Aufsicht/CoronaVirus/CoronaVirus_node_en.html.
[12] See for example. various BaFin notices for investors to exercise caution with buy recommendations for shares on BaFin’s website: https://www.bafin.de/SiteGlobals/Forms/Suche/EN/Expertensuche_Formular.html?cl2Categories_Format=Meldung>s=dateOfIssueOrModification_dt+desc&documentType_=News&sortOrder=dateOfIssueOrModification_dt+desc&cl2Categories_Thema=Marktmanipulation&language_=en.
[13] In this regard, BaFin also raised awareness before the coronavirus pandemic. See https://www.bafin.de/SharedDocs/Veroeffentlichungen/EN/Fachartikel/2019/fa_bj_1901_Market_Making_en.html.
[14] FSB, COVID-19 pandemic: Financial stability implications and policy measures taken (15 April 2020), available on FSB’s website: https://www.fsb.org/2020/04/covid-19-pandemic-financial-stability-implications-and-policy-measures-taken/.
[15] IOSCO website: https://www.iosco.org/.
[16] ESMA website: https://www.esma.europa.eu/press-news/esma-news/esma-renews-its-decision-requiring-net-short-position-holders-report-positions.
[17] ESMA website: https://www.esma.europa.eu/about-esma/covid-19.
