Portuguese Market at a Glance

In the aftermath of COVID-19, initial signs of economic upturn have recently been counterweighed by a combination of rising inflation, tightening of monetary policy, supply chain disruption and the Russian-Ukrainian conflict. Portugal’s GDP is reportedly expected to grow around 6% in 2022, but periods of stagnation are likely to follow in 2023. As of December 2022, inflation levels are expected to average 6.5% in 2023, which, combined with a tightening of monetary policy, has brought about rising interest rates.

Still, the Portuguese banking sector continues to show positive signs notably on asset quality, returns and solvency. Somewhat surprisingly, non-performing loan (NPL) and stage 2 loan ratios decreased in 2021 (down to 3.5% and 10.5% respectively in Q2 of 2022) despite the end of the COVID-19 legal and voluntary moratorium schemes. The sector’s returns have improved both in terms of assets and equity, with the five largest banks in Portugal registering an 80% growth in turnover in the first semester of 2022 vis-à-vis the same period in 2021, in an aggregate amount of EUR1 billion. Regarding solvency, total own funds and Common Equity Tier 1 (CET1) ratios have remained fairly stable throughout 2022.

The Portuguese banking sector’s soundness will play a key role in addressing the economic challenges anticipated for 2023. However, as the ghost of recession (re)appears in Europe, Portuguese banks are expected to exercise some restraint in future deals as well as a tightening conditions in loan transactions (especially in the leveraged loan market), giving room to alternative lenders and other lenders acting on a cross-border basis. As a result of inflation and the increase in interest rates, it is likely that an increase in distressed debt will follow. Restructuring, recovery, and placement in the secondary market will be a key challenge for banks and borrowers throughout 2023.

On the upside, continued digitisation is expected from banks, as well as new market entries from fintech players. Additionally, the virtual asset market is likely to continue its development and growth trajectory in Portugal, despite new regulatory challenges.

ESG concerns will also remain on the agenda for 2023, with an expected increase of green and sustainability-linked financial products in loan and debt securities (notably bonds) documentation.

On the other hand, corporate borrowers can likely anticipate higher interest rates on their debt and restructure existing debt and/or diversify their sources of funding and reduce their dependency from banks.

Crypto-assets and Fintech

The Portuguese crypto-asset market has been on a path towards maturity for some time now. As of December 2022, the crypto-industry remains largely unregulated, except where the assets qualify as e-money, financial instruments or securities. However, specific concerns have been addressed from a regulatory perspective, notably with regards to AML, cybersecurity, and investor fraud.

Since the 2020 amendment to the Portuguese AML Framework (transposing AMLD5), which established a licensing requirement for Virtual Asset Service Providers (VASPs) to operate in Portugal, seven market players have successfully registered as VASPs with the Bank of Portugal and are authorised to carry out activities related to virtual assets in Portugal.

The AML Framework was further amended in 2021 essentially to clarify that virtual assets that behave like securities or financial instruments shall be subject to the latter’s regulatory framework, and that offshore VASPs are not captured by the Portuguese AML requirements, including the need to register with the Bank of Portugal. In addition, the Bank of Portugal has recently published a draft regulation on the AML duties, procedures and tools applicable to VASPs, which entails specific (often more robust) duties in light of the regulator’s view on increased AML risks in dealings with crypto-assets. These include, for instance, the use of screening technology, detection of mixers or tumblers, specific rules on source of assets, and travel rules. The draft is under public consultation and approval, and entry into force is expected to occur in 2023. Future steps on regulation are expected to be taken at the EU level, notably with the forthcoming approval of the MiCA Regulation.

On the fintech side, innovation has focused mainly on areas such as digital onboarding, robo-advisory, and open banking, fuelled by collaborations between incumbents and fintech start-ups. Since its creation in 2018, the Portugal FinLab has contributed to fostering innovative projects, in close connection with the national regulators. The recent creation of “free technological zones” (ZLT), regulatory sandboxes for sponsors to develop and test their technology-based goods and services, will contribute to the dynamism of the Portuguese fintech market. Crowdfunding, on the other hand, remains fairly untapped in the Portuguese market, with only four platforms and four platform managers registered with the Securities Market Commission (CMVM).

Crypto and fintech are expected to remain key industries in 2023, with new opportunities and innovation-driven models arising in the banking and financial sector, namely under the EU’s Digital Finance Package.

Restructuring, Recovery and Loan Trading

After “surviving” the end of COVID-19 moratoria schemes, which covered a significant portion of bank loans, without major impacts on performance indicators, the looming effects of inflation and rising interest rates are expected to bring additional pressures to borrowers. Stage 2 and non-performing loans are therefore expected to increase in the Portuguese banks’ sheets, which may in turn reflect increased activity in the secondary market for loan trading.

From a regulatory perspective, changes will flow from the recent approval of the Directive on Credit Servicers and Credit Purchaser, which sets forth a harmonised framework for addressing NPLs originating in EU banks through the creation of a level playing field secondary market. The Directive will be transposed into national law by December 2023, and will require servicers to obtain an authorisation in their home EU member state, which may then be passported to other member states. Credit servicers will have to ensure that the assignment remains neutral to the borrower, as well as complying with a set of information duties vis-à-vis the borrower. In turn, credit purchasers will have to appoint a credit institution or an authorised servicer to perform servicing activities in respect of consumer loans.

Diversifying Sources of Funding

Another major driver of legislative change in the Portuguese financial landscape has been the need to facilitate access to alternative sources of financing, especially for SMEs, to reduce indebtedness and dependency from banks. Traditional bank loans remain the most relevant source of financing for businesses in Portugal (around 42%), while the total amount of loans is an average of 80% of the country’s GDP,

Participating loans were introduced in 2022 as a form of hybrid (or quasi-equity) funding. In a nutshell, participating loans are remunerated and/or repaid based on the borrower’s results and any outstanding amounts may be converted into equity, notably upon default.

Loan funds were also recently introduced in the Portuguese law as a subtype of alternative investment fund (AIF). These funds are expressly authorised to originate loans, to participate in loan syndicates or to acquire loans originated by banks (performing or non-performing). Certain changes are expected from a cross-border perspective with the approval of the AIFMD2 Proposal, notably with the introduction of a “loan issuance passport” for EU loan-originating AIFs.

It will be interesting to see how these – and other - alternative types of lending will play out in 2023 within the general financing landscape. Although some forms of shadow banking have been visible, credit granting in Portugal remains a strictly regulated activity, restricted to duly authorised entities. In an effort to prevent and combat unauthorised financial activities and to protect consumers, a recent legislative act set forth a general duty for market operators to refrain from marketing and recommending financial products provided by unauthorised entities. The act also establishes reporting duties in relation to unauthorised banking practices, while expanding the supervisory powers of Portuguese financial regulators.

ESG and Sustainable Finance

ESG concerns are also expected to remain a focal point in the Portuguese financial sector. Green and hybrid bond placements in Portugal have surpassed EUR6 billion in volume. Clients’ awareness of green loans, ESG-linked loans or sustainability-linked loans has increased, and banks and other lenders face increasing pressure to make their loan books “greener”. There has also been a notable progressive increase in the incorporation of ESG KPIs in loan transactions during the last year, associated with better margins and other more favourable debt conditions.

As regards changes in hard law, the Sustainable Finance Disclosure Regulation is now fully in force (with limited exceptions), and asset and portfolio managers will need to be prepared to report and disclose ESG-related information in an appropriate and efficient manner, taking into account the framework set out in the Taxonomy Regulation and the Low Carbon Benchmark Regulation. It will be interesting to monitor how investors react to the available data and labelling, and how the information translates into the funds’ performance (if at all).

The legislative proposal for the long-awaited European Green Bond Standard (EU GBS), which was published alongside the Strategy for Financing the Transition to a Sustainable Economy on 6 July 2021, is expected to facilitate the issuance of high-quality green bonds and pave the way for a true “European green bonds” market. Although the green bond regulation has not yet been approved and the EU GBS label is therefore not yet available, the key features of the proposal can already be used in the preparation of green bond issues.

The New Portuguese Banking Act

In 2021, the Bank of Portugal approved a final draft of the new Portuguese Banking Activity Code which, if passed by Parliament, will replace the current legal framework governing banking activities and the provision of financial services in Portugal. The proposal for a Banking Activity Code represents a significant change to the banking landscape.

The draft aims to consolidate, in a single piece of legislation, the framework for banking activities in Portugal. It also proposes to introduce legislative changes that reflect the recent developments in the Portuguese banking sector, while taking the opportunity to transpose the European Union Directives that make up the “Banking Package”, especially Capital Requirements Directives (CRD) and the Bank Recovery and Resolution Directive (BRRD2). Key changes proposed in the draft include:

• the adoption of a single type of financial company;
• a more stringent regime for cross-border transactions with non-EU countries;
• new rules on transparency, conflict of interests and transactions between related parties;
• new standards for subcontracting by financial companies; and
• the expansion of the Bank of Portugal’s supervisory powers, especially regarding qualified holdings.

The new Code is now expected to be approved in 2023.