A new Constitution for the financial market system is now in place

To recall, following the recommendations of the de Larosière report, the European Commission presented, in September 2009, detailed proposals aimed to reform the European framework for supervision of the financial system. The proposed framework is based on two new pillars: a European Systemic Risk Board (ESRB) and a European System of Financial Supervisors (ESFS). However, there is no legal basis in the Treaty which allows the creation of the new EU-level authorities: a European Banking Authority (EBA), a European Insurance and Occupational Pensions Authority (EIOPA) and a European Securities and Markets Authority (ESMA), with binding powers. The Commission has proposed that the European Systemic Risk Board and the European Supervisory Authorities will be established on the basis of Article 114 TFEU (Article 95 of the EC Treaty), stressing that the creation of the ESRB and of the ESFS will improve the functioning of the Internal Market. The proposals confer to the ESAs enforcement powers, powers to adopt emergency decisions and powers to settle disagreements between competent authorities, one could say that the draft regulations go far beyond what is necessary to achieve the objective pursued – “improving the functioning of the internal market.” The measures proposed under Article 114 TFEU have to be adopted by the Council and the European Parliament (ordinary legislative procedure) with QMV required at the Council. It is impossible, therefore, to veto the proposals. The European Parliament and the Council have worked towards reaching a first reading agreement on the different draft regulations on financial supervision. Obviously, the behind close doors meetings have been fully used. 

Last December, the EU finance ministers reached a general approach on the three regulations setting up the new EU supervisory authorities, giving a mandate to the EU presidency to start negotiations with the European Parliament. However, the MEPs have immediately slammed the member state’s compromise deal for weakening the Commission’s proposals. There were deeply divisions between the EU member states, MEPs and the European Commission. The main point of contention has been the binding powers of the EU supervisory authorities over national regulators. Whereas the Council has agreed that EU supervisory authorities’ powers over banks, securities firms and insurance companies should not override national supervisors' decisions, the MEPs wanted to give them broad powers. Last July, making concessions towards MEPs, the EU finance ministers agreed to give the Belgium EU presidency a new mandate.
On 2 September, the EU triangle, the EU presidency, the MEPs and the European Commission, reached an agreement on the reform of the EU framework for supervision of the financial system, which includes draft regulations setting up a European Systemic Risk Board and the three supervisory authorities. On 7 September, Ecofin, the EU Finance Ministers, endorsed the compromise deal. The European Parliament approved the package of five regulations, in first reading, on 22 September. Then, at a forthcoming meeting the Council will formally approve the proposals without further discussion. Hence, the European Systemic Risk Board and the three authorities can be operational from 1 January 2011 as initially planned. The Council has not yield to all the MEPs' demands but the Commission proposal has not been water down. In fact, the European Parliament has claim victory as ESAs will have more powers than member states have foreseen when they reached a general approach last December.
The Coalition Government welcomed the compromise deal however it has made several concessions, transferring important powers to the new EU financial authorities. 

The Commission's draft regulation on Union macro prudential oversight of the financial system and establishing a European Systemic Risk Board was, therefore, approved. The European Systemic Risk Board will be a body without legal personality, responsible for safeguarding financial stability. The ESRB main role would be to identify risks to financial stability and prevent or mitigate their impact on the financial system within the EU. The Systemic Risk Board will collate and analyse information received from banks. And, where necessary, it will issue risk warnings, for example, on the financial situation of individual banks and recommendations for action to address any identified risks. Such warnings and recommendations might be of a general nature or could concern individual Member States, European Supervisory Authorities, and national supervisory authorities. The ESRB recommendations will not be legally binding. Nevertheless, their addressees are expected to react to them. In fact, if the addressees do not act on the ESRB’s recommendations, they must explain their reasons. In order to increase the pressure on the addressee “to act or explain”, all warnings and recommendations must be transmitted to the Council, European Commission, whilst those related to supervisory issues should also be transmitted to the relevant ESA. National supervisors would be required to justify themselves to the Council and/or the ESAs if they fail to observe the ESRB’s recommendations.
Moreover, it may also decide by a qualified majority of two-thirds of the General Board, on a case by case basis, whether warnings and recommendations should be made public in order to increase pressure for prompt action. 

The European Parliament was able to introduce in the draft proposal the requirement for the ERSB to elaborate a colour-coded system reflecting situations of different risk levels. Hence, its warnings and recommendations would have to indicate to which category the risk belongs. 

The ESRB will be composed of a General Board, a Steering Committee, a Secretariat, an Advisory Scientific Committee and an Advisory Technical Committee. The main decision-making body will be the General Board whose members with voting rights will be the Governors of national central banks, the President and the vice-President of the ECB, a member of the European Commission, the chairpersons of the three European Supervisory Authorities, the Chair and the two Vice-Chairs of the Advisory Scientific Committee, and the Chair of the Advisory Technical Committee. However, the Member States’ representatives of the competent national supervisory authorities will have no voting rights. The General Board will act by a simple majority of members present with voting rights. 

The Commission has followed the compromise reached by the European Council and proposed that the ESRB’s chairperson to be elected for 5 years by the Members of the General Board of the ESRB. The UK has been against the idea of the ECB President becoming chair the new ESRB. However, under the compromise deal, at insistence of the European Parliament, the ESRB will be chaired by the President of the ECB for a term of five years. The legislation will be reviewed after three years, new arrangements for the subsequent terms would be then decided. The ESRB shall have been independent of the ECB in order to represent the whole of the EU and not solely the Eurozone. 

The European Parliament was also able to increase its role as the ESRB's president and the Vice-Chairs will be subject to the European Parliament’s public hearings. 

The Council and the European Parliament endorsed, therefore, the creation of a European System of Financial Supervisors, comprising the three new European Supervisory Authorities: the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA). Thus, on 1 January 2011 the three existing Committees of Supervisors which only have advisory powers will be replaced by the three new European supervisory authorities (ESAs). The independence of national regulators is now at stake. The ESAs will be Community bodies with legal personality and they will have legal, administrative and financial autonomy. They will assume all of the tasks and competences of the current Committees of Supervisors but they will also have greater authority than them. The UK’s Financial Services Authority will see its powers substantially reduced.

 The three ESAs will not be based in Frankfurt as the European Parliament proposed, just the European Insurance and Occupational Pensions Authority (EIOPA) will be based there, the European Banking Authority (EBA) will be located in London, and a European Securities and Markets Authority (ESMA) in Paris. 

The recently adopted regulations will transfer powers from national financial supervisors to the new European bodies. Hence, Member States will have reduced control over the supervision of their financial institutions.
The day-to-day supervision of financial institutions will remain at the national level, with national supervisors, but the European System of Financial Supervisors has a central role in the supervision of cross-border groups. The ESAs will coordinate supervision of cross-border financial groups. They will contribute to the establishment of common regulatory and supervisory standards. Moreover, the ESAs will solve disputes between national supervisors, monitor the application of EU law, they will have direct supervisory powers over credit rating agencies and make decisions during crises. The Member States have therefore, agreed, to confer biding powers on ESAs over national regulators. The ESAs will be able to take decisions directly applicable to financial institutions where national regulators fail or incorrectly apply an EU law or technical standards, where there is a disagreement between national authorities and in emergency situations declared by the Council. 

A single EU rule book applicable to all EU financial institutions will be established. The aim is to remove the differences in the national transposition of EU law, in order to ensure uniform application of rules in the EU. Hence, the new European Supervisory Authorities will contribute to the development of “a single set of harmonised rules.” They will develop binding technical standards in their respective areas that will be applied in all financial institutions in the EU. Such draft technical standards will be adopted by the Authorities on the basis of qualified majority of the members of the Boards of Supervisors. 

Where the European Commission is empowered to adopt regulatory technical standards by means of delegated acts the ESAs may develop draft regulatory technical standards which are then submit to the Commission for endorsement. The Commission may only adopt a regulatory technical standard without a draft from the Authority if it has not presented it within the required time. The draft standard shall be forwarded to the European Parliament and the Council. If the Commission decides not to endorse the draft regulatory technical standards or amendment it, they shall be sent back to the relevant ESA with an explanation. The Authority may amend it taking into the Commission's proposed amendments. If the Authority does not present an amended draft regulatory technical standard, or has not amended it on the basis of the Commission's proposed amendments, the Commission may adopt the regulatory technical standard with the amendments it deems important or reject the standards. The regulatory technical standards are adopted by the Commission in the form of regulations or decisions so they can have direct binding legal effects. The European Parliament or the Council may object to the delegated act, in this case a regulatory technical standard shall not enter into force. 

The ESAs may also develop implementing technical standards, through implementing acts, which are then submit to the Commission for endorsement and forwarded to the European Parliament and the Council. If the Commission decides not to endorse a draft implementing technical standard or to amendment it, the draft implementing technical standard shall be sent back to the Authority with an explanation. The ESA may amend the draft taking into account the Commission's proposed amendments however, if the Authority does not present or has presented a draft not amended on basis of the Commission's proposed amendments, the Commission might adopt the implementing technical standard with the amendments it considers important or reject it. The Commission may only adopt an implementing technical standard by means of an implementing act without a ESAs draft, if ESA has not presented one within the time required in the regulation. The implementing technical standards will be adopted by means of regulations or decisions and will enter into force after publication in the Official Journal of the European Union. The compromise deal has given to the European Parliament a say in the development of the technical and implementing standards. 

Moreover, the ESAs would also have the power to issue non binding guidelines and recommendations on the application of Union legislation to national supervisory authorities and financial institutions, in those areas not covered by the technical standards. The national supervisors would have to apply such guidelines while taking individual decisions, such as, on licensing and supervision of financial institutions. If national supervisory authorities decide not to comply with such recommendations they are obliged, under the proposal, to explain their decision to the Authorities. 

The ESAs are also empowered to monitor how national supervisors implement EU law. In order to ensure consistent application of EU’s rules, the European Supervisory Authorities would be able to investigate cases where the behaviour of a national supervisory authority has been deemed to be in breach of Union law, or non- application of Union law, including the regulatory technical standards and implementing technical standards as well as to adopt a recommendation for action addressed to the relevant national supervisor to comply with EU law. The compromise deal has reduced the Commission’s role, hence if the national supervisory authority does not comply with such recommendation, the European Commission would no longer be empowered to address a decision to the national supervisory authority concerned, requiring it to either take specific action or to refrain from an action, but to issue only a “formal opinion”. 

Moreover, when the national supervisor does not comply with the abovementioned formal opinion, failing to act on breaches of EU law, the European Supervisory Authorities will also have the power to adopt decisions addressed to individual financial institutions in respect to EU law which is directly applicable to them, requiring the necessary action to comply with their obligations under EU law. Such ESA's decisions will prevail over any previous decision adopted by the national supervisor. The three ESAs would have therefore enforcement powers against individual financial institutions. This is without prejudice to the Commission's powers under Article 258 TFEU - infringement procedures against member states. The compromise deal has kept the Commission proposal and, consequently, ESAs are allowed to give direct orders to individual financial institutions, issuing decisions directly applicable to them.

The majority of the Member States have accepted that the ESAs should have the power to adopt specific emergency decisions, in crisis situations. But, according to the Council conclusions the Commission should “(…) ensure that such power should not impinge in any way on Member States' fiscal responsibilities.” The European Supervisory Authorities will have an active role in crisis situations such as by facilitating cooperation and exchange of information between the national supervisory authorities. The Commission has granted to itself the power to determine whether there is an emergency situation. Such power has been endorsed by the European Parliament, however, fortunately, the member states have not made such concession. Hence, under the compromise deal, it will be the Council, and not the Commission, to decide whether there is a crisis situation. Consequently, the Council may, therefore, adopt a decision addressed to an ESA, determining the existence of an emergency situation. The ESRB or the ESAs shall issue a confidential recommendation to the Council if they consider that an emergency situation may arise. The European Parliament and the Commission must be informed “without delay” if the Council determines the existence of an emergency situation. In this case, the Authorities will be empowered to adopt individual decisions, under which national competent authorities would be required to take action, in accordance with EU legislation, including regulatory technical standards and implementing technical standards, in order to address any risks to the functioning of financial markets, by ensuring that financial market participants and competent authorities satisfy with that legislation requirements. ESAs have been granted the power to require national supervisors to jointly take specific action to remedy an emergency situation. If a competent national supervisory authority does not comply with such ESA decision, and does not apply EU legislation , including regulatory and implementing technical standards or breaches those legislative acts, and it is necessary “to restore the orderly functioning and integrity of financial markets or the stability of the whole or part of the financial system in the European Union”, and where the relevant legislative acts are directly applicable to financial market participants, ESAs may adopt biding decisions directly addressed to financial institutions, requiring the necessary action to comply with obligations under that legislation. Such ESA’s decisions will prevail over any competent authority previous decision related to the same matter. 

Consequently, according to the Commission, ESAS would be able to “adopt harmonised temporary bans on short selling on EU securities markets.” ESAs would be, therefore, allowed to temporarily forbid or restrict certain financial activities, that threaten the functioning of financial markets, in cases provided in sectoral legislation such as the proposal on short-selling, or if it is required in the case of an emergency situation. It is important to recall that the European Commission has also recently proposed a draft regulation on short selling and certain aspects of Credit Default Swaps (CDS) which, if adopted, will harmonise requirements relating to short selling in the EU as well as the powers that regulators may use in exceptional situations, in case of serious threat to financial stability or market confidence. Under the draft proposal ESMA would be, therefore, empowered to adopt measures with direct effect, limiting or forbidding short selling.ESMA would be able to override measures taken by national regulators. 

Moreover, the new ESAs will have direct supervisory powers over credit rating agencies (CRAs). ESMA would be responsible to register credit rating agencies. It would also be empowered to withdraw the registration or suspending the use for regulatory purposes of credit ratings. The supervisory powers would entail the power to request information and to conduct investigations or on-site inspections. The Commission has already presented a proposal amending the Regulation on Credit Rating Agencies, to include the responsibilities and powers of ESMA. 

The European Supervisory Authorities will also have legally biding mediation powers to settle disputes between national supervisors for the banking, insurance and securities sectors, in cross-border situations. A dispute settlement mechanism is therefore foreseen. In case of disagreement between national supervisory authorities, a conciliation phase will be set up, during which ESAs would assist the supervisors in reaching a joint agreement. However, under the compromise deal ESAs may assist the authorities in reaching an agreement at the request of the competent authorities or by “its own initiative.” As the MEPs have pointed out “ESAs will be able to impose legally-binding mediation.” The MEPs and the Council have endorsed the Commission proposal, hence if national supervisors are unable to reach an agreement, the European Supervisory Authorities would “settle the matter.” The Authorities may, therefore, take a decision requiring national supervisors to take specific action or to refrain from action, “with binding effects for the competent authorities concerned, in order to ensure compliance with Union law.” They would, therefore, override, in this way, national supervisors’ decisions. If the national supervisory authorities concerned do not comply with such decision, failing to ensure that financial institutions comply with requirements directly applicable to them by virtue of EU legislation, the Authorities will have the power to adopt individual decisions addressed to financial institutions requiring the necessary action to comply with their obligations under EU law which is directly applicable to them. Such decisions will prevail over any competent authorities’s previously adopted decisions related to the same matter. 

There was a general endorsement, at the European Council, to confer to the new ESAs powers of binding mediation over national supervisors. The UK and a small number of other Member States could not agree to such approach. Hence, the European Council agreed “that the European System of Financial Supervisors should have binding and proportionate decision-making powers (…) in the case of disagreement between the home and host state supervisors, including within colleges of supervisors” but on the condition that “decisions taken by the European Supervisory Authorities should not impinge in any way on the fiscal responsibilities of Member States.” The Commission has proposed a safeguard clause in order to ensure that the ESAs’ decisions in settling disputes between national supervisors and in emergency situations would not impinge on the fiscal responsibilities of the Member States. The so called safeguard clause just covers those provisions. 

Under the Commission draft proposals, if a Member State considers that the measures taken by the Authorities in settlement situations impinge on its fiscal responsibility, it may notify the Authority concerned and the Commission that the decision will not be implemented by the national supervisory authority. The member state would be required to justify its action and to “clearly” demonstrate how the Authority’s decision impinges on its fiscal responsibilities. Then, the Authority would decide whether to maintain or revoke its decision. Where the Authority maintains its decision, the Member State may refer the matter to the Council and the decision of the Authority is suspended. The Council then would decide whether the decision should be maintained or revoked, acting by qualified majority. The suspension of that decision would be terminated, if the Council decides to maintain the Authority's decision, or if it does not take a decision within two months. 

Under the compromise deal, if a Member State considers that such decision impinges on its fiscal responsibilities, it may notify the Authority and the Commission “clearly and specifically” explaining “why and how the decision impinges on its fiscal responsibilities.” The decision of the Authority shall be suspended. Then, within one month, the ESA shall inform the Member State as to whether it maintains, amends or revokes its decision. The Authority will have to state that fiscal responsibilities are not affected, if it keeps or amends its decision. In case of the Authority maintains its decision, the Council, will decide by a majority of the votes cast, simple majority, as to whether the Authority's decision is maintained. If after considering the matter the Council does not take a decision the Authority's decision shall be terminated. 

The Commission has proposed an expedited procedure for the Authority’s decisions in emergency situations. If a Member State believes that such decisions impinge on its fiscal responsibilities, within three working days, it may notify the Authority concerned and the Commission that the competent authority will not implement such decision. However, it must justify such action as well as “clearly demonstrate how the decision impinges on its fiscal responsibilities.” Then, within ten working days, the Council will decide whether the Authority's decision is maintained or revoked, acting by qualified majority. The Authority's decision would be kept if the Council does not take a decision within ten working days.

Under the compromise deal, if a Member State considers that such decision impinges on its fiscal responsibilities, it may notify, within three working days, the Authority, the Commission and the Council that the decision will not be implemented by the competent authority, but it has to “clearly and specifically explain why and how the decision impinges on its fiscal responsibilities.” The Authority's decision shall be suspended. Then, within ten working days, the Council shall take a decision, with a simple majority of its members as to whether the Authority's decision is revoked. If the Council after considering the matter, does not take a decision to revoke the Authority's decision, the suspension of the Authority's decision shall be terminated . If the Council has taken a decision not to revoke a the Authority’s decision, and the Member State concerned still regards such decision as impinging upon its fiscal responsibilities, it may request the Council to re-examine the matter, setting out, “ clearly …the reasons for its disagreement with the decision of the Council.” The Council will have then four weeks to confirm its decision or take a new one. 

The compromise deal does not secure the UK’s fiscal sovereignty. The safeguard clause continues to be insufficient. The European Parliament was able to waterdown the compromise reached by the EU Swedish presidency last December as under the present compromise deal the opportunities to invoke the safeguard clause are limited. The MEPs were able to introduce the so called “anti-abuse clause.” Hence, under the compromise deal recently endorsed by the MEPs and Member States “Any abuse of this Article, in particular in relation to a decision by the Authority which does not have a significant or material fiscal impact, shall be prohibited as incompatible with the internal market.” 

A Board of Appeal will be created to which any natural or legal person, including national supervisory authorities, may appeal against a decision by the ESAs as regards coherent application of Community rules, action in emergency situations, and the settlement of disagreements. The Board of Appeal’s decisions would be subject to appeal before the Court of First Instance and the Court of Justice. Member States as well as the EU institutions, and any natural or legal person, may lodge a direct appeal before the Court of Justice against the Authority decisions. Moreover, if an Authority has an obligation to act and fails to take a decision, proceedings for failure to act may be brought before the Court of First Instance or the Court of Justice in accordance with Article 265 TFEU. 

Each European Supervisory Authority will comprise a Board of Supervisors, a Management Board, a Chairperson; and an Executive Director. The Board of Supervisors will be the principal decision-making organ of the Authorities. Members of the Board of Supervisors would be required to “act independently and only in the Community's interest” and to not take instructions from a Government of a Member State or from any other public or private body.
All decision-making in the Board of Supervisors will be done through a system of “one member, one vote.” All member states would be therefore on an equal foot, with the same voting power. This entails reduced influence to the UK as the member state with the biggest financial sector. As a rule, decisions by the Board will be taken by simple majority including decisions on disputes between national supervisors. The Board of Supervisors would adopt some decisions by qualified majority voting, such as decisions related to the adoption of technical standards, guidelines and recommendations as well as budgetary matters. 

The Commission has estimated the total costs of creating the ESAs around €40 million in the first year of operations and around €60 million after two years. The EU budget will fund 40% of the costs and Member States 60%.The Commission has also estimated that €2.5 million of the total will be funded through fees paid by supervised entities to the new Authorities. 

There is a review clause whereby the Commission is required to every three years publish a report on the ESAs operation, particularly the report will assess the appropriateness of continuing “separate supervision of banking, insurance, occupational pensions, securities and financial markets” and whether “it is appropriate to supervise prudential supervision and the conduct of business separately or by the same supervisor.” The EU Commissioner for Internal Market, Michel Barnier, has said that the present regulations are " just a first step (...)” In fact, ESAs powers are very likely to be extended, including direct supervisory powers over banks and other financial institutions.

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