First step towards new EU supervision finally taken

On 22 September 2010, the European Parliament (EP) voted on the creation of new EU-wide supervisory bodies. The decision came after protracted disagreements with the Council due to some member states’ reluctance to transfer powers to the EU level (see newsletters from April 2010 and June 2010). While national supervisors keep substantial regulatory powers, the three new EU bodies respectively supervise banks, insurance and pension funds, and financial markets. They will be allowed to directly intervene and have a final say when:

• national authorities do not correctly apply EU laws,
• national authorities supervising a cross-border financial firm have a dispute, and
• when the Council announces an emergency situation and risky financial products need to be stopped.

In addition, the European Systemic Risk Board (ESRB) will warn, but not be able to act, against macro-economic risks such as speculative bubbles in the stock market.

Many have commented that the structures were watered down in the negotiations with member states, rendering them insufficient and ineffective. The decision is therefore seen as only a first step to stricter EU supervision of financial firms operating EU-wide. The new supervisory bodies will be operational from 1 January 2011 onwards.

In the European System of Financial Supervisors, the three new European Supervisory Authorities (ESAs) will be dealing with supervision

• at the financial firm level in the banking sector (European Bank Authority, EBA),
• in the securities sector (European Securities and Market Authority, ESMA), and
• in the insurance and pensions sector (European Insurance and Occupational Pensions Authority, EIOPA).

Their decisions will aim at harmonisation of a core set of specific rules or key standards, e.g. on reporting, and effective implementation of EU law by EU member states’ financial authorities.

The main points of disagreement between the Council and the EC were solved as follows :

• a “fiscal safeguard clause”: there are strict safeguards and procedures which prohibit ESAs to take decisions that will have budgetary (i.e. fiscal) consequences for the member states, such as ordering to bail out a bank.
• ESAs have final decision making power when different national supervisors overseeing an EU wide operating financial firm are in disagreement.
• In case of an emergency, ESAs receive the power to take direct action towards member states’ authorities, and if these still do not act, directly to the financial firms. The Council insisted it had the final power to declare an emergency. ESAs have powers to stop speculation and trading in dangerous financial products, e.g. short selling, when the EU Council declares an emergency and when future EU legislation provides for such powers.
• The chairperson of the ERSB is the chair of the European Central Bank to guarantee some status of independence.

Supervision exclusively at the EU level was attributed to ESMA for inspecting Credit Rating Agencies registered in the EU. In future, ESMA and other ESAs might directly supervise EU financial operators after new EU legislation has given such powers. It is likely that ESMA will be provided with direct supervision of operators in derivatives markets after relevant new EC proposals will be approved (see this newsletter).
Disagreement came especially from the UK, who did not want to ‘give away the keys of the City of London’, but also some Eastern and Central European countries, as well as Spain and France.

The following critique has been voiced by commentators of the newly agreed EU’s financial supervision mechanism:

• ESAs and the ESRB do not have sufficient powers or regulatory reach to strongly intervene to prevent financial instability, nor to supervise financial firms regarding their impact on society and the environment. Systemic risk, which they have to prevent, is narrowly defined as instability within the financial system sector.
• The ESRB has no power to act and can only provide early warnings and recommendations about “interconnected, complex, sectoral and cross-sectional systemic risks”.
• Too little supervisory powers are being transferred to the EU level, especially when considering that many banks operate EU-wide and that there is a single financial and capital market.
• Too little coordination between the different ESAs, because based in three different European capitals (EBA in London, EIOPA in Frankfurt and ESMA in Paris) and only coordinated through a ‘Joint Committee’.
• It is not clear whether the power struggle between the national and EU level will end or will continue within the operation of the ESAs.
• Insufficient funding has been allocated to properly staff the supervisory bodies: the total budget of the three ESAs (€ 40 million), starting with 150 staff members (300 staff members after four years), is very low compared to e.g. the UK Financial Supervisory Authority which has around 3.300 staff.

Business groups welcomed the new supervisory system as it will decrease costly divergent compliance and reporting requirements per country, and called for open access to the new ESA’s through advisory bodies. Business already has great influence on the existing supervisory bodies that will be replaced by the ESAs, e.g. at CEBS. The Greens were able to insert into the text that non-profit organisations will be invited to participate in advisory stakeholder groups and that adequate financial compensation be provided.

The ESAs will replace the existing advisory supervisory committees as of 1 January 2010. According to a revision clause, the effectiveness of the supervisory system needs to be assessed every three years. Proposals for strengthening the supervisory system could therefore be made and agreed by the EP and the Council.

For more explanation and overviews see, for instance, the Commission website (see pdf format), and European press articles (1) and (2). For the full texts see here.

Meanwhile the UK government is planning to re-organise national supervision by mid-2012, by moving macro-prudential regulation of banks and insurance companies to the Bank of England and supervision of financial markets and overall conduct to a new Consumer Protection and Markets Authority (CPMA). Previously, responsibilities were divided in a tripartite system between the Financial Services Authority (FSA), the finance ministry (Treasury) and the central bank (Bank of England). There are concerns that the UK’s influence in EU supervision will be diminished if only the CPMA will represent the UK on ESMA.