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Over the past decade, the European Union has rolled out a host of new regulations aimed at fostering more competitive capital markets and mobilising private investment towards critical goals, including the digital transition and climate emergency.
One of the EU’s core levers for enacting change has been the Capital Markets Union (CMU) project, which was set up to reduce market fragmentation in the bloc. It seeks to allow funds to flow freely across borders and thus support business growth throughout Europe.
Ultimately, it is hoped this will harmonise market rules, enhance transparency, and streamline processes.
Yet, according to the Council of the EU, despite recent progress in the growth of EU capital markets in the past few years, approaching nearly 50% relative to GDP since 2014, there remains a notable gap in their development.
In recent months, this has led to calls among several European finance ministers to significantly step-up efforts with regards to the CMU and wider markets regulations across Europe.
Specifically, Europe’s policymakers believe it is critical that more regular discussions take place around which priorities are addressed for the next legislative cycle.
This may well expedite the rate at which European markets regulations are implemented or amended over the coming years.
Market participants must ensure they remain well informed ahead of these changes prior to implementing new products or strategies. After all, failing to remain compliant comes with a significant cost.
One of the CMU-related regulations earmarked to be evaluated by the European Securities and Markets Authority in 2024 surrounds Packaged Retail and Insurance-based Investment Products (PRIIPs), which encompass a range of investment products that financial institutions offer retail investors.
Any meaningful changes to how the EU regulates PRIIPs will undoubtedly peak the interest of market participants operating in both the EU and the UK, particularly given the UK’s Financial Conduct Authority signaled its intention to depart from the EU’s regulatory approach to PRIIPs earlier this year.
The UK’s confirmation of changes to PRIIPs adds a layer of intricacy for financial institutions already grappling with stringent reporting requirements.
This divergence – which may be exacerbated if the EU makes further amendments to its PRIIPs regulation over the next few years – not only introduces operational reporting headaches, but also underscores the broader ramifications of regulatory misalignment.
One of the greatest operational challenges financial institutions are now facing is the need to adhere to both the EU and UK versions of PRIIPs.
This dual compliance requirement means financial entities must develop, implement, and maintain distinct reporting frameworks to meet the evolving standards on both sides of the English Channel.
The divergence in PRIIPs regulation subsequently translates into heightened compliance costs for financial institutions, with the need to tailor reporting mechanisms to the nuanced requirements of both the EU and the UK, creating a strain on resources.
But beyond the reporting challenges, there are also differences to be understood in the methodology of calculating fees under these regulations, with different countries in the EU favouring different methods. This has to be done on a regular basis, and for many, in multiple jurisdictions with regional nuances.
Therefore, another key challenge for the management companies is in dealing with the calculation of fees, with different interpretations in the UK and many different European countries.
To address this growing challenge, the prudent move for financial institutions is to invest in sophisticated systems capable of handling the intricacies of dual compliance.
Not only do they need to be able to rely on operational architecture that can support varying calculation methodologies, they need to support different reporting formats, and be able to pull and efficiently utilise data which can oftentimes be scattered across internal systems, or even more basically for some, held in Excel spreadsheets.
This will of course necessitate an increase in operational expenditure.
From a systemic perspective, these rising costs could potentially hinder innovation and investment in other critical areas, ultimately impacting the industry’s ability to adapt and thrive.
However, market participants are left with little choice but to address the complexities that have arisen through the divergence of regulatory schemes in increasingly globalised financial markets.
As the financial landscape continues to evolve and the EU comes under mounting pressure to ramp up its efforts surrounding the CMU, policymakers and markets watchdogs must strive for greater alignment to ease the burden on industry participants.
Aside from enhancing operational efficiency, a more harmonised approach would foster a regulatory environment that puts investor protection first without imposing unnecessary burdens on financial institutions.
The success of these efforts will determine the industry’s ability to thrive in a post-Brexit world, where regulatory complexities are the new norm.
Kifaya Belkaaloul is head of regulatory at NeoXam