European Financial Supervisory Architecture: “unfinished work” with many Brexit headaches and a fundamental greenfield for a new EU Continental project Professor Marco Lamandini CFA roundtable – Amsterdam 18 April 2018
The EU supervisory architecture in permanent motion! Evolutionary, but subsidiarity-friendly, integration is a necessity: Either you keep pedalling or you fall! This is true for Europe, it is also true for its financial supervisors! But with clear sector-specific, institution-specific and product-specific variations ! Three key open points: 1. How to reconcile Single Market policies (level playing field grounded in a Single Rule Book) with sufficient flexibility to accomodate fundamental differences in market structure, macro-economic country-specific conditions, legacy problems in the North/South Divide? 2. How to reconcile microprudential policies with macroprudential and monetary policies (e.g. strenghtening capital requirements in a recession or when monetary policy is highly espansionary? dispersion of MREL securities and very paternalistic investor protection)? 3. One institutional model of supervisory architecture fits all? Proportionality and adjustment capacity are key! Even more so to respond to sudden changes of the political set-up (Brexit, US isolationism): an interesting green-field to test EU resilience
A bit of background: (I) Why a EU supervisory architecture, in the first place? In the words of the European Commission (Communication 20.9.2017, 3) a. Financial integration lies at the heart of the Single Market and of the Economic and Monetary Union b. It is easier to conduct financial activities cross-border if these activities are regulated and supervised consistently across all Member States ( Single Market rationale ) c. Financial integration – for all its benefits – also expands the channels of contagion among Member States in the case of adverse shocks. Inadequate supervision in a Member State has spill over effects and becomes a source of risk elsewhere ( financial stability rationale )
(II) The infancy: The Lamfalussy procedure and 3L3 Committees
(III) EU supervisory cooperation: from “small” to “extra large”! Scholten, Ottow, Institutional Design of Enforcement in the EU: The Case of Financial Markets , in Utrecht Law Review , Vol. 10, No. 5, December 2014, p. 85. Available at SSRN: http://ssrn.com/abstract=2552571
(IV) The current architecture of the ESFS: a snapshot
(V) ESAs not enough to address the vicious circle sovereigns/banks: the Banking Union As the financial crisis evolved and turned into the Eurozone debt crisis, it became clear that, for those countries which shared the euro and were even more interdependent, a deeper integration of the banking system was needed as a precondition for Euro area financial support . That’s why, on the basis of the European Commission roadmap for the creation of the Banking Union, the EU-19 agreed to establish a Single Supervisory Mechanism and a Single Resolution Mechanism for banks. Non Euro MS can also join. The Third Pillar is still on its way ! Deposit Guarantee Schemes (DGS) are still national and with limited fire power and risk dispersion.The Commission’s EDIS proposal for re-insurance and then co-insurance with the new DGS Directive is stuck political progress is slow.
(VI) Banking Union and CMU tell different stories! (a) Banking Union was momentous but to some extent easier Banking is comprehensively regulated in the EU-28 by a mix of uniform – maximum harmonisation and minimum harmonisation rules (CRR, CRD IV , BRRD), grounded on Basel standards and their straightforward extension to the entire European banking industry (with little room for proportionality calibrations: but 2016 Risk Reduction Package is meant to better address it; more to come, though!). No surprise that retail commercial banking requires fully-fledged establishment in the EU and being subject to EU supervision: no “third country equivalence (TCE) recognition” but need to coordinate for GSIIs out of the Eurosystem. Banking Union offers a good example of a “two speed” EU exercise of enhanced cooperation: in the EMU O&D are centrally exercised and supervision is centralised (is it a competitive advantage? Nordea move to Finland seems to say yes) . T-122/15 L-Banken acknowledged that exclusive competence over all prudential tasks listed in Article 4 SSMR is granted to the ECB! NCAs are (legislatively) delegated some responsibilities on LSIs under ECB control …
No surprise SSM fared reasonably well so far but... with new challenges There are new legal challenges: a. Risk of discrimination : the enforcement of harmonized national laws by the ECB may occasionally lead to diverging outcomes because of still national preferences embedded in the national law the ECB is called to apply (e.g. fit and proper, in particular integrity requirements). It is new that the CJEU has to look also at national law! (see GCEU order 12 September 2017, T-247/16, Trasta Komercbanka), but now also ESMA may be called to enforce IFMD national implementing rules if applicable to ELTIFs ; b. Complexity : an example are compound proceedings (vertically with NCAs and horizontally with SRB) and their judicial review (pending case CJEU C-219/17, Fininvest); another example is the division of competences with EBA ( now question on EBA remit to plan EU supervisory priorities: does it threat ECB independence ?) c. “Creeping ” “monopolisation ” : do ECB supervisory competences implicitly encompass also prudential tasks under national law which are however considered within the frictional remit of ECB (ECB letters of end March 2017)? And also SRB recently had its baptism of fire! Banco Popular pending cases show that “ shared ” competences between SRB and NRAs (FROB) are a multiplier of legal claims at both national and European level!
(b) CMU is more of a patchwork… but there are good reasons to move towards a CMSS Heterogenity is the rule: It is difficult to adopt a unitary approach. Different: i. market players ii. products iii. markets and many “speeds” of their European regulation. It is clear however that: (a) market infrastructures are key and they are European; (b) accounting and auditing still too national (thereby impairing effective comparability and delaying inward investment flows to Europe); (c) cross-border/interstate activities call per se for a single EU entry point for supervision (see now crowdinvestment EC March 2018 initiative!) Five Presidents: Single CMU Supervisor as longer term objective! In the words of the European Commission: “ more seamless supervision promotes more integrated financial markets in the Capital Markets Union ” . “ Direct supervision at the EU level is in many cases the most effective way of delivering supervisory convergence, thereby removing barriers to cross-border activities and the scope for regulatory arbitrage ” (EC, Communication, 20.9.2017, p. 9)
(VII) Brexit is just an elephant in the room: CCPs, CRAs, AIFs and more! Two numbers are enough: UK trade surpluses from financial services with EU in 2014: a. 12 Billion revenues from market infrastructures (46% of overall EU sector revenues); 70% of clearing Eurodenominated derivatives trades in London; LCH clears over € 500 Billion a day with SwapClear (notional amount over € 87 Trillion) b. 6 Billion revenues were from asset management (26% of overall EU sector revenues). c. banking: 23% of overall EU sector revenues, and mostly thanks to US and foreign localisation in UK. 5,500 City-based firms rely on 336,421 passports! With an “ hard ” Brexit, London based CCPs can clear EU trades under the EMIR third country equivalence (3CE); No surprise CCPs regulation and supervision becomes a thorny issue (today EC adopted 39 3CE under 14 different EU pieces of legislation): UK shall ensure over the long run i. Substantive equivalence; ii. Compliance with equivalent rules; iii. Reciprocity (reciprocal recognition of EU firms). And this may be still not enough!
No surprise the first move was a new remit for ESMA on TC CCPs supervision, with a “ silver bullet ” for a possible relocation Can EMU accepts that most of Euro-denominated transactions be cleared out of EU and of EMU? ECB was unsuccessful in its first attempt: GCEU T-496/11. But those were different times, well before Brexit (and current difficult negotiations). Two new events : A. ECB made its recommendation 22 June 2017 and Commission endorsed it with opinion 3 October 2017 to change Article 22 ECB Statute (to respond to GCEU concerns) and get the necessary firepower to impose relocation, if needed; B. proposal of 13 June 2017 for a Regulation amending Regulation No 1095/2010 to establish the “CCP Executive Session” (One Head, 2 independent and members of the NCA and NCB where CCP is established) within ESMA tasked with supervision of Union and third countries CCPs post recognition. But ESMA can also propose to the Commission the the CCP should not be recognised, if the CCP is of “specifically substantial systemic significance” : in this case CCPs would be authorised to provide clearing services to EU clearing members and EU clients only if relocated and established in one Member State!
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