The financial crisis highlighted the need for regulatory reform, but the EU has seized the opportunity to make other changes, notably what appears to be a step towards the creation of a single European regulator.
Regulatory reform of the financial services sector has been a necessary response to the financial crisis, which has exposed a number of weaknesses. There are a multitude of initiatives and reform proposals at an international, EU and domestic level that will change the shape of the regulatory framework.
Notably though, the EU in particular has seized the opportunity to propose structural and other reforms that seem to be a clear move to vest greater regulatory and supervisory powers in the various European institutions and appear to be a first meaningful step in the creation of a single European regulator.
At the forefront of these developments are the proposals for the creation of a European financial supervisory framework, comprising a European Systemic Risk Board, charged with macro-prudential oversight, and new European supervisory authorities, the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pension Authority (EIOPA), intended to create an over-arching European framework for the supervision of individual regulated businesses.
Under the original European Commission proposals, the EBA, ESMA and EIOPA would not replace national regulators, which would remain responsible for the day-to-day supervision of individual businesses, but would be tasked with ensuring consistent interpretation and application of EU regulations. To this end, the new authorities would have the role of developing technical standards, which would have direct legal effect and be directly binding on individual businesses and would be part of an overall objective to create a single European rule book.
The authorities would also have the ability to issue non-binding guidelines and recommendations to national supervisors and to individual businesses on matters not covered by the technical standards. Further, the Commission proposals contemplate a mechanism under which the EBA, ESMA and EIOPA would be able to enforce the consistent application of EU regulations by national supervisors and, in emergency situations, require specific action to be taken by national supervisors.
Although the objective of seeking consistent application of European rules across members states seems a laudable aim, it is unclear how the ability of the new European authorities to make and enforce directly applicable regulations and to give guidance and take action against national regulators will operate to undermine the willingness – or ability – of national regulators to take decisions and provide interpretive assistance and guidance at a local level.
Given the differing regulatory and legal systems and concepts existing across members states, this is an important function of national regulators, particularly against the background of a trend of placing increased reliance on a ’copy-out’ approach to implementation of European financial regulations, under which the text of European directives, frequently ambiguous and difficult to interpret, is replicated in local implementing legislation.
In a move to dilute suggestions that its proposals for a new European supervisory regime are a step towards a single European regulator, the Commission proposed that the three new authorities be based in different locations, with the EBA in London, ESMA in Paris and EIOPA in Frankfurt. However, on 10 May, the Economic and Monetary Affairs (Econ) Committee of the European Parliament voted on its proposed amendments to the Commission proposals.
Under these amendments, all three authorities would be based in Frankfurt and operate on a more closely integrated basis under which they would acquire direct supervisory responsibility for systemically important cross-border financial institutions. They would also acquire the power to impose temporary bans on specific financial products assessed as unduly risky.
This approach, if adopted, would go substantially beyond the original Commission proposals. It is likely to meet with political resistance but whatever the final shape of the proposals, the outcome is likely to be a radical change in the landscape for the regulation and supervision of financial firms and a significant shift of regulatory power to European institutions.
The desire to exert European control over financial markets is also evident in the proposal to regulate managers of alternative investment funds, including private equity and hedge funds. Under the AIFM proposal, launched by the Commission in April 2009, managers of alternative investment funds would be required to adopt and comply with organisational, structural, transparency and disclosure requirements designed to create a ’brand’ for funds established in the EU.
In a move generally regarded as political, the proposal sets conditions for the marketing to EU investors of funds established and managed outside the EU. These are likely to be impractical for non-EU managers in many typical fund jurisdictions to meet, severely curtailing the ability of EU institutional investors to invest outside the EU and, correspondingly, the ability of non-EU managers to raise funds from within the EU.
This proposal was also recently considered and voted on by the European Parliament’s Econ Committee. On 17 May, it voted through proposed amendments that take an even more restrictive approach to the marketing to EU investors of funds established outside the EU, giving the Commission power to determine which jurisdictions meet the required standards. The Council of the EU’s position on the marketing of non-EU funds is rather more pragmatic and is aimed at preserving the ability for such funds to be marketed under national private placement regimes subject to more attainable conditions.
There is a considerable gulf between the Council’s position and the position proposed by the Econ Committee, and the ’third country’ marketing provisions in the proposals are highly political. It is unclear where the balance will be struck, but there is likely to be a significant impetus for a final agreement to be reached in the next few weeks in order that an agreed text can be voted on in the full plenary vote of the European Parliament scheduled for July.
Simon Currie is a partner at Covington & Burling