Over the last 2 years, EU Member States were due to align their national legislative framework to European standards in several financial areas, such as payment accounts and services, financial instruments markets and insurance distribution. The Romanian authorities were put under strong pressure by the European Commission in June 2017 to provide a legislative solution for the application of the Payment Accounts Directive (Directive 2014/92/EU) in domestic law, a requirement they were meant to have fulfilled by 18 September 2016. The EU institutions opened an Infringement procedure urging Belgium and Romania to enact Directive 92 in their national legislation. The Romanian Parliament managed to find a solution in due time to close the infringement case, by accelerating the debates and approving the local law in November 2017.
The banking sector continued to consolidate through mergers and acquisitions which are in various stages of completion. This process may be stepped up, amid strong competition, high costs of staying in the market and decisions at group level on exiting certain markets. The bank business model continues to focus primarily on households, whereas lending to non-financial corporations is growing at a sluggish pace and sovereign exposure remains significant. Profitability of the banking sector, although high in 2017, does not look to be sustainable at this level in the long term, based on its existing structure. Only half of the systemically important banks created value for their shareholders in 2017, with a positive margin between the return on equity and the cost of equity.
In the insurance sector, as from 1 October 2018, companies were required to align with the Insurance Distribution Directive whereby the following aspects are regulated: (1) More transparency should be provided for the client; (2) There should be an appropriate distribution in line with clients’ needs and demands to avoid mis-selling; (3) There should be an increase in the accessibility of other distribution channels, (4) Clients should benefit from advice when purchasing insurance products. More emphasis is also given to professionalisation of distributors by specialised training courses and continuous learning within the insurance sector. Moreover, under the General Data Protection Regulation (GDPR) the way personal data are processed will be improved, even though no real gaps have been identified in this respect. These new rules are likely to increase customer confidence in the insurance market, and will be beneficial for the industry.
Private pension funds hold more than 90% of their assets domestically and retain a fairly low risk profile, with 75%-80% of all holdings invested in money market instruments and various bonds. As the banking sector continues the deleveraging process, pension funds provide the alternative capital for development, contributing to the financing of public and private companies and the optimal allocation of resources in the economy via the stock market. One possibility for development is infrastructure investment, where pension funds could buy bonds in special projects, issued to support the country's developing infrastructure. 2018 was marked by intense discussions about the future of Pillar II pensions in Romania. The level of contributions was reduced to 3.75% of gross income (from 5.1% in 2017). Together with the overall transfer of contributions to the employee, this had the effect that most clients accumulated on average 12% less funds in their accounts even though the total amount that went into the system went up by RON 1 billion. The market was constantly concerned by rumours that Pillar II will be nationalised.
For the capital markets the last few years have been marked by positive steps towards Romania coming closer to Emerging Market status. However, additional progress will be needed, particularly in relation to new listings and transaction volumes on the stock exchange. In order for the Romanian capital market to be promoted by the global index providers (MSCI, FTSE-Russell, S&P Dow Jones, STOXX) to the Emerging Markets category, the capital market must comply with a series of qualitative and quantitative criteria.
During the last two years, steps have been taken to develop and enhance financial education for individuals, such as the setting up of the Platform of Financial Education and Fluent in Finance Platform, as well as the issuing of the Practical manual for the financial services user and the Capital market and Investments manual. In spite of this, and although a National Financial Education Strategy is being prepared, Romania is still among the lowest ranking for financial education according to international statistics.
During the last days of 2018, the Romanian Government adopted Emergency Ordinance (EO) no. 114/2018, without consulting the business community and the industries affected and without an impact study. Such measures highlight the lack of public consultation and predictability within Romania’s economy and discourage future investments in the financial services sector.
Companies from the financial services sector will be unable to muster sufficient resources to invest in developing financial infrastructure and education in order for Romania to reduce the existing gap with other EU Member States: Romania has the lowest degree of financial intermediation in the EU (26.4%), the lowest number of small and medium sized companies per 1000 inhabitants (43), and the lowest digitalization level.
During 2017 and 2018 a series of cases continued to raise concerns about the transparency and predictability of the legislative process, on the one hand, and about the suitability and the effectiveness of several laws on the other.
These included a package of three legislative initiatives presented as being necessary due to overriding consumer protection objectives but which may affect the financial sector’s stability: the capping of interest rates, the limitation of the recoverable amount of assigned receivables, and the elimination of the writ of foreclosure feature of credit contracts for individuals, all meant to be applicable to ongoing lending contracts.
Neither the initiators of the law, nor the members of relevant Committees in Parliament have presented or requested preliminary assessments as backgrounds for the urgency of such intervention in ongoing banking contracts.
It was the banking industry which finally requested an independent professional entity to undertake an analysis of the potential impact of such legislative initiatives, which highlighted as notable consequences a decrease in lending with direct impact on consumption, negative effects on disposal of non-performing loans (NPLs), an economic slowdown and a drop in investments.
Moreover, these draft laws were proposed with a total lack of correlation with the regulations and decisions adopted at European level which deal with the disposal of NPLs in EU member states and the cleaning-up of bank balance sheets. The ongoing clean-up of banks’ balance sheets also faced obstacles from a fiscal perspective, as in August 2017 the Government limited the tax deductibility of expenditure related to non-performing exposures sold by banks to 30 %, in contrast to the previous system of full tax deductibility.
The three draft laws were adopted by Parliament in the last days of 2018 without the business community being consulted. At the beginning of 2019 they were appealed against to the Constitutional Court as they were in breach of several constitutional principles such as security of legal relations, economic freedom, the guarantee of ownership and, last but not least, the non-retroactivity of civil law.
Another problematic and uncoordinated proposal which was introduced during 2018 envisages the application of Law no.77/2016, on datio in solutum to Prima Casa loans, without an assessment of its effects.
Last but not least, a series of very populist initiatives claiming, for example, to facilitate access of people to finance for personal development were launched and approved, despite public opposition due to complex and inefficient procedures and processes and lack of proper incentives.
Any new legislation should be subject to real consultations involving all stakeholders. Before even being considered, a comprehensive impact study/analysis should be carried out, to make sure negative consequences are averted. Furthermore, Romania’s commitments under the EU Accession Treaty, such as consultation with the ECB before passing legislation affecting the banking sector, and strict observance of European Directives, should be respected.
The main requirements for the effective functioning and development of the insurance sector are coordination of Romanian and European legislation, as well as the implementation of best practices in the field in order to improve consumers` confidence in the insurance industry and to ensure adequate protection of it.
Although the Romanian insurance market ended 2017 with an approximately 3.5% increase in consolidated GWP compared to the previous year, insurance companies still face the challenging process of adaptation and market consolidation under the Solvency II regime requirements.
The main strategies for stimulating the development of the insurance market in the next few years will focus on diversifying the business model of insurers, increasing the penetration of insurance products among consumers (including by digitalisation) and the adoption of a consistent legislative framework.
The insurance industry should focus on measures to permanently update and simplify the distribution of insurance products. This objective may be achieved by diversifying distribution channels. One potential approach would be to increase credit institutions’ involvement in the distribution chain, which would build on customers’ confidence in this market sector.
Moreover, it is very important for the insurance market to take all necessary steps to generate customers’ interest in life and health insurance products, by making these more accessible and attractive, as it has been proven that stimulating the availability of insurance products is the most useful way to encourage consumers to see their benefits and purchase them.
Under the General Data Protection Regulation, the way personal data are processed will be improved, even though no real gaps were identified in this respect. These new rules will increase customers’ confidence in the insurance market, and bring benefits to the industry.
In this new legal environment, it is very important to be in close relations with the regulator to ensure the correct implementation of these provisions, so as to avoid wrong interpretation. Poor implementation has a negative effect on the insurance market, both for insurers and for their customers.
Insurers should also work to improve legislation and apply it correctly to set best practice within the market. The industry should issue a code of conduct and a code of ethics for setting best practices among insurers. This would bring significant benefits to the entire insurance process.
PAID is an insurance pool set up in 2009, after a study by the World Bank, to provide cover against earthquakes, flooding and landslides. The earthquake risk is significant in Romania, with 2 major earthquakes during the 20th century (in 1940, magnitude of 7.4 and in 1977, 7.2). Legislation sets out a requirement for home owners to take out insurance cover for natural disaster risk up to an insured amount of EUR 20,000, but local municipalities do not carry out inspections and do not enforce the penalties set out in law.
The yearly premium of EUR 20 for an insured sum of EUR 20,000, set by the 2009 law, is much lower than the EUR 34 recommended initially by the World Bank after thorough modelling. PAID was set up as a private company, with 12 insurers incorporated in Romania as its shareholders. PAID is distributed by 21 insurers, which are also involved in the sale of optional home insurance for the risks of natural disasters above EUR 20,000 and for the other types of risks (fire, theft, liability).
Since August 2013, it has only been possible to cover the risk of natural disasters by PAID, and since mid-2015, it has been mandatory to subscribe to a PAID policy first before subscribing to an optional policy. PAID has now become a fairly robust company, which is profitable, and which meets European Solvency 2 requirements.
Issue 1: the artificially low premium set by the 2009 law does not allow the purchase of enough reinsurance to face an extreme event. In the case of an extreme event like the 1977 earthquake, PAID would not be able to pay all claims.
Issue 2: with PAID’s current portfolio the % penetration rate is far too low for mandatory insurance. This low penetration is a major exposure for home owners and also for the state budget. An earthquake comparable to that of 1977 would create damage to houses in the range of EUR 5 billion, while only 1.5 billion is insured by mandatory PAID insurance and by optional insurance. The exposure of the state budget is, consequently, huge. Moreover, there would be a likely surge in the price of construction material due to high demand.
Issue 1: The FIC recommends the correction of the policy premium deficit by the introduction of a 10% deductible on the EUR 20,000 sum insured (meaning that in a case of claim, the first EUR 2,000 of damage would not be indemnified by PAID). This solution has been thoroughly researched and discussed with ASF.
Issue 2: The FIC recommendation is to gradually increase the penetration of PAID; after removing the premium deficit indicated above, the law should be amended:
To increase the commission level (currently 10%, i.e. only EUR 2 to cover sales incentive and administration costs) in order to make it affordable to sell PAID policy as a stand-alone item.
To allow other distribution channels than home insurance companies, such as bundling PAID policies with utilities.
Life insurance protects people in cases of accidents and death, prevents financial collapse and avoids a family becoming dependent on the public social assistance system. Stimulating private behaviour is a measure of protection applied by most OECD countries and a large number of European Union countries. In Romania, life insurance has developed slowly and now has a penetration rate of only 0.29% of GDP.
Romania already has one of the highest rates of social security contributions in Europe. Moreover, projected demographic change will increase pressure on the social security budget and have a negative impact on economic growth in the long term, as well as leading to a likely fall in the amount of welfare available to Romanians.
In order to stimulate voluntary financial protection and boost the development of the life and health insurance market in Romania, the FIC recommends the application of a tax incentive for the purchase of life and health insurance policies with deductibility for both employees and employers.
Since their launch in 2007-2008, private pension funds in Romania have reached combined net assets under management of more than EUR 10.4bn and have significantly diversified their investment portfolios. Pension funds have thus begun to play an increasingly important role on the local capital markets, such as the Bucharest Stock Exchange (BVB), where they are already the largest domestic institutional investors. Pension funds now have holdings in excess of EUR 1.7bn in BVB listed equity. They hold an estimated 20% of the market's free float and account for roughly 15% of the market’s trading volumes. Last but not least, they have also had a decisive role in the success of all recent public offers on the market, IPOs and SPOs run by both public and private companies.
Currently, private pension funds hold well above 90% of their assets domestically and retain a rather low risk profile, with 75%-80% of all holdings invested in money market instruments and various bonds. As the banking sector continues the deleveraging process, pension funds provide the alternative much needed capital for development, contributing to the financing of private or public listed companies and the optimal allocation of resources in the economy via the stock market. One possibility for development is infrastructure investment, where pension funds could buy bonds in special projects, issued to support the country's developing infrastructure. While bonds are always a simple option, there are also several other ways to raise capital needed not just for building roads and improving railways, but also to enhance the health and energy infrastructure.
The last two years have been marked by lively discussions about the future of Pillar 2 pensions in Romania. On the one hand, the level of contributions was reduced in 2018 to 3.75% of gross income (from 5.1% in the previous year). Together with the overall transfer of contributions to employees this has had the effect that most clients accumulated on average 12% less funds in their accounts even though the total amount that went into the system went up by RON 1 billion. On the other hand, the market was concerned by constant rumours that Pillar 2 will be nationalised.
The FIC believes that maintaining a strong and legally-predictable private pension system (especially Pillar 2) is critical to improve the levels of investment in and liquidity of capital markets, which are essential for the promotion of the Bucharest Stock Exchange to Emerging Market status.
Private pension funds make up a solid bedrock of national capital, which can be used to consolidate financial markets and develop infrastructure. Consequently, the FIC considers that the continued development of Pillar 2, by phasing in contributions as provided by law, would bring significant benefits. We also recommend that the Government should continue the privatisation of state-owned-companies through the Bucharest Stock Exchange.
Over the last 2 years, EU member states were due to align their national legislative framework to European standards in several banking areas, such as payments accounts and services, financial instruments markets and insurance distribution.
The Romanian authorities were put under strong pressure by the European Commission in June 2017 to provide a legislative solution for the application of the Payment Accounts Directive (Directive 2014/92/EU) into domestic law, a requirement they were meant to have fulfilled by 18 September 2016. The EU institutions opened an Infringement procedure urging Belgium and Romania to enact Directive 92 in their national legislation. The Romanian Parliament managed to find a solution in due time, to close the infringement case, by accelerating the debates and approving the local law in November 2017.
The Directive gave all legal EU residents the right to a free of charge basic payment account, especially for unbanked vulnerable consumers or, for a reasonable fee, for non-vulnerable ones, regardless of their place of residence. It also improved the transparency of payment account fees, with the aim of making it easier to compare and switch. Consumers already holding an active payment account should also be entitled to benefit from a payment account with basic features.
The final definition agreed in Romania for „vulnerable customer” was settled at the threshold of an income of 60% of the average gross salary. So far, the effects of the law have not really resulted in an increase in the banked population, for various reasons that are not related to payment account charges.
Another important legislative event in the banking field is the PSD 2 Directive, which was due to be implemented by Member States by 13 January 2018.
Its aim is to contribute to a more integrated and efficient European payments market by extending the scope of PSD1 to intra EU payments in all currencies and to payments where only one of the payment service providers is located in the EU/EEA, for those parts of the transaction that are carried out on EU territory.
Measures to reform MiFID II were transposed into Romanian legislation by Law no. 126/2018 on financial instruments markets, on 26 June 2018. The new legislative provisions aim at improving investors’ protection, increasing market transparency, as well as promoting trading and clearing competition. The impact of the law is significant, as the market architecture has been changed as well as the way transactions are carried out.
These new rules are translated at banks’ level into implementation of various organisational processes and procedures, changes to IT systems, reviews and amendments of the contractual framework and development of the reporting of transactions to relevant authorities. There are also new requirements for credit institutions in relation to structured deposits trading and the distribution of fund units, which need to be complied with starting from next year.
The MiFID law also brings some implementation challenges to banks, since it transposes to the monetary market the intermediation typology specific to the capital markets, after the two markets had being differently regulated in many respects and had evolved distinctively. Moreover, the legislation brings important compliance challenges to brokerage houses acting on the capital market.
Finally, under the Insurance Distribution Directive 2016/97/EU consumers were offered greater transparency in relation to the price and costs of insurance products, as well as simpler, standardised insurance product information for non-life insurance products to help them make more informed decisions and established rules on business conduct to help consumers to buy products that meet their needs.
The IDD should have applied from 23 February 2018, but the EU agreed to postpone the application date to 1 October 2018.
In Romania the Directive has been implemented recently by Law no.236/2018 on insurance distribution.
Both Government and Parliament, in their capacity as initiators of normative acts for the transposition of European legislation, should make it a priority to involve professional associations and other interested and relevant entities in working groups, with the aim of identifying the best implementation options. Existing local practices, local context and existing local laws should also be considered when transposing EU legislation, with the aim of effectively achieving its real objectives. Moreover, successful implementation of EU legislation involves more than reproducing the directives into national laws. It also takes time and effort to complete the process by issuance of secondary legislation. Thorough business and operational impact analyses need to be conducted together with market participants, as the necessary clarity and detail can only be set out in the implementation norms.
Timely cooperation between law-makers and market participants and sharing and acknowledgment of implementation cases/examples in other EU Member States, together with proper consultation of relevant European institutions in the implementation process, can therefore be the right ingredients for the effective transposition of EU regulations.
Since 2014, the Romanian capital market has passed through a number of reforms which aimed to improve the investment landscape. Their main focus has been on: easing investors’ access to the market and fiscal compliance, reducing the cost of the market, improving the servicing of investors’ rights, simplifying procedures related to primary markets for equities and bonds and developing the market infrastructure. New regulations on lending & borrowing operations and OTC transactions have recently been approved. Moreover, the largest IPO of a state-owned company (Electrica) in the history of the Romanian capital market took place in 2014, as well as the unfreezing of the IPOs of privately-owned companies, starting with Medlife in December 2016 and followed by several others which raised more than EUR 312 mn from the market. In September 2016, the Bucharest Stock Exchange was placed on the Emerging Markets Watch list by FTSE-Russell. Under FTSE Russell’s latest decision, published in September 2018, the Romanian capital market was maintained on the list of countries that have substantial potential to be upgraded to Emerging Market status. FTSE Russell upgraded the only outstanding criterion, Liquidity, from ‘Not Met’ to ‘Restricted’ following an improvement in broad market liquidity.
Hidroelectrica’s listing would be important as it would be sizeable enough to allow the Romanian stock market to comply with the outstanding MSCI criteria (single stock and broad market liquidity criteria) and the FTSE Russell criterion (broad market liquidity criterion).
The development is needed for the Romanian capital market to become a viable financing alternative for Romanian companies, to allow the financial system to be more stable and to enable it more easily to absorb shocks. Moreover, it would aid the development of the pensions system, support the privatisation programme of state-owned companies, and increase the transparency and performance of Romanian companies (both state and privately owned) by applying corporate governance standards, as per the Corporate Governance Code and related regulations. Moreover, funds investing in emerging markets are estimated to be 25-30 times larger than those investing in frontier markets (Romania’s current status). Promotion to Emerging Market status would benefit not only the capital market, but also the whole economy of Romania.
The programme for state owned companies to be listed on the BVB should be continued, by both accelerating the listing of new companies on the capital market, as well as by encouraging SPOs for already listed companies. There are several suitable IPO candidates: Hidroelectrica, CE Oltenia, Romtelecom, Bucharest Airports, Tarom, CFR, Salrom, Constanta Port, and CEC Bank.
The listing procedures should be formalised in a multi-year strategy approved by the Government, where companies being prepared for listing are named, with clear timelines and expected listing dates set for each of them. In order for the transactions to have high chances of success, stakes to be listed should be at least 20% of the total shares issued by these companies. Organisation of all IPOs and privatisations should be centralised under one government entity, which should help ensure the highest market standards for each transaction. Consequently, a formalised decision- making process related to initiation of the listing process should be established.
An experienced team of consultants should be involved in the completion of the listing process from the stage of approval of the privatisation strategy. The remuneration of the privatisation committees should largely focus on the completion of the privatisation process so that delays are avoided.
Considering the oversubscription to retail tranches in previous public offers, the FIC recommends that the Government should have a Civic Shareholding Programme, as a long term programme to make the investment process on the Romanian capital market more accessible to citizens and to stimulate retail investors to buy shares in the public offers of state-owned companies, by allocating dedicated retail tranches in each public offer.
Corporate governance of State Owned Enterprises (SOEs) is a prerequisite for sound preparation of a company for an IPO and this will continue to be enhanced after the company becomes listed. Consequently, the corporate governance regulatory framework for SOEs should not be changed in order to decrease corporate governance standards, but instead, standards should be raised.
A sustainable structure for Romanian sovereign and development funds should be created, as the two types of funds should be subject to the following goals: to maximise shareholders’ value and promote the development of the financial sector. The growth of the capital market should also allow SOEs and private companies to raise the necessary funding for investment projects, and this should lead to an acceleration in GDP growth. But the IPO of Hidroelectrica or other SOEs should not be conditional in any way on the existence of Romanian sovereign or development funds, but should be seen as an opportunity, given the momentum that the Romanian capital market has for being promoted to emerging market status.
The fiscal registration procedures for foreign investors which are interested in trading on the Romanian capital market should be simplified.
Development of the private pensions sector should be promoted by extending the investment horizon. This would allow the funds to participate in the financing and development of infrastructure, private equity and real estate projects. The disestablishment of Pillar 2 or any negative measure to affect the Pillars would have irreversible negative effects on Romania’s international perception by foreign investors, on local capital market development, as well as on the value of individuals’ savings and their trust in the authorities. It would also have a negative effect on the drive to improve financial literacy across the country, for which Romania has the lowest score in the EU.
Fiscal measures should be introduced to stimulate long term investments and financing of companies through the capital market and to attract individuals to invest some of their savings in listed companies (either indirectly, by subscribing to equity funds, or directly, by investing in the stock exchange).
Financial literacy programs in Romania have been developed and supported by the private sector. They have been organized by banks, non-banking financial institutions, the stock exchange, asset managers, pension funds, insurers and their professional associations. The reach of these programs has constantly increased from year to year to a larger number of individuals and an extended geographical area.
An example also supported by the public authorities is the Platform of Financial Education (involving the National Education Ministry, the Bucharest Economic Studies Academy, the National Authority for Consumer Protection, the Romanian National Bank, and the Romanian Banking Association) and its Practical manual for the financial services user, which contains useful information about banks, leasing, capital markets, investment funds, private pensions and insurance. Another example is the Capital market and Investments manual, studied as an optional course in the 11th grade, and the Fluent in Finance platform, both dedicated to personal finance, savings and investments.
In July 2018 the first step in the preparation of the National Financial Educational Strategy was made through the Cooperation Agreement for joint activities in the field of financial education and the preparation of the National Financial Educational Strategy concluded between the Ministry of National Education, the National Bank of Romania, the Ministry of Public Finance, the Romanian Banking Association and the Financial Supervision Authority.
Legislation has also been passed to improve financial literacy:
In the payments sector:
A leaflet listing individuals’ rights in a simple, clear and accurate manner will be provided by banks (the draft Law for implementing the PSD2 Directive.)
In the insurance sector, more information on the features of insurance products must now be provided to individuals and intermediaries are required to offer personalised insurance products taking into account the personal needs of the individuals (Law no 236/2018).
In the capital markets sector - more detailed information on transactional costs, charges and incentives must be provided to individuals before and after each transaction (Law no 126/2018).
Efforts to improve the level of financial education should be intensified, so that Romania does not have to wait another generation to benefit from the effects of financial literacy. Financial literacy projects run by the private sector have achieved good outcomes, but in order to be able to extend these nationally, to a larger number of individuals and a wider geographical area, the support and commitment of the public authorities is essential.
Source: Calculations based on IMF and Eurostat data