The Committee's Opinion on proposals for European financial supervision - Treasury Contents

Examination of Witnesses (Questions 20-39)



  Q20  John Thurso: Some organisations have told our staff that they fear the new structure will not respect the better regulation principles, and measures will be imposed without proper consideration of their effect on competitiveness. Do you agree with that and, if you do, how would you want to see them change?

  Dr Alexander: First of all, the European system of financial supervisors is decentralised; it relies on Member State supervisors to discharge most responsibilities and financial supervision. One of the key roles it is playing is, each ESA publishes a rule book or a code to help provide more harmonised and uniform practice of prudential supervision across the European Union. I agree with the earlier comments: this is very detailed; a lot of specifics regarding who does what in these proposals; but that is precisely to promote accountability and to show that the decision-making structure is accountable and that it is transparent, regarding ESAs and their relationship with the Member State Supervisors. I do not really think that it deviates from any type of good practice principle.

  Q21  John Thurso: Any dissent? No. Members of the Board of Supervisors are meant to act independently, yet decisions on technical standards and guidelines and recommendations are being taken by qualified majority vote. Is there a contradiction in that? Professor Portes?

  Professor Portes: No, this is absolutely standard in European Union practice. We have lived with it for many years, and to see it extended in this way at least there is a possibility that you might get some outcomes. As it stands, if you go to a meeting of CESR or CEBS you say, "What am I here for? What are they here for?" That is one of the few new promising possibilities here, that you might actually get these fiercely independent—jealous of their authority—regulatory agencies to come to some common principles that would actually be imposed on the recalcitrant ones.

  Q22  John Thurso: Given London's position as the clear major financial centre in Europe and one of the world leaders, is there any threat in the possibility of regulatory decisions being taken by QMV, particularly for London and its competitiveness?

  Professor Portes: Of course, there is always that possibility but we live with that possibility in many areas. Again, take the Alternative Investment Funds Management draft Directive, the original proposals are completely unacceptable and you can see I think that we are going down the right road that is not in the end going to be unacceptable to the City of London, and it could not be; that is just a practical matter. Qualified majority voting could not, in practice and in political practice, override a really strong objection, backed up by substance, from the most important financial centre in the European Union.

  Dr Danielsson: I do worry about that because I am looking, as I say, at the one specific area mentioned, which is the compensation area. Clearly one gets a sense of where they are heading, that they are looking to set European-wide rules on systemic risk; and those rules might be correct for European countries with small financial systems but they might not be appropriate for London; because what constitutes systemic risk in London may be different than in other European countries. I could see a possible conflict between the objects of London on the one hand and the objects of Europe on the other. Given the fact that these proposals are so light on any detail as to what is systemic risk or what the mandate of the report is, it is something that does give me a worry.

  Q23  John Thurso: The devil is obviously always in the detail. Is there anything in the process? I get the sense people agree with the principle; at what point should we be concerned with the detail?

  Dr Danielsson: I do worry about the fact that they do already say, as I said earlier, that the Authority may be able to take actions that require national supervisors to apply requirements effectively. They are already assuming some power even at this early stage. This is contradictory to some of the statements in the document. At least those things I would like to see clarified.

  Professor Portes: How can you clarify that further? It is a straightforward statement. Finally somebody might be able to tell a national regulator what to do. Again, it is very hard to see, even by a qualified majority vote, telling our national regulator what to do—especially if you take the matter, which seems to concern you, Jon, compensation. We are out front in this for good or for ill. We are actually being tougher than other jurisdictions—or going to be tougher as things seem to be going.

  Dr Alexander: The UK plays a very important role presently in the three level three committees; and they will continue to play a very important role in influencing the decision-making of the European Supervisory Agencies. I cannot imagine that they would make decisions that are directly contrary to the views of the FSA, unless what the FSA want to do is in direct breach of EU law of an EU Directive. Let me briefly mention also, regarding the Systemic Risk Board it does not have legal personality; it has got no binding power. It meets simply in a pre-crisis situation to be involved in surveillance information and assessment; and if there is a crisis they cannot make decisions in a crisis because they have no legal power; but they are meant to try to raise red flags to issue warnings and recommendations and that is key; because in Europe the focus has always been on Member States, by Member State Central Banks, so we have not had enough focus on the broader European system. The ECBs played a role recently in that; but this is an incremental step regarding the Systemic Risk Board; and what we see on the supervisory agencies is simply a continuation of what we had with the Lamfalussy process, where we have got the supervisors already negotiating setting standards, overseeing each other's implementation through peer review, and this will be continued one step further in this framework.

  Q24  Mr Plaskitt: Can I come back to this question of emergency powers and looking at Article 10, which is in the draft. It says that what can trigger an emergency situation and the powers that go with it are "adverse developments". Is it enough to rely on that?

  Professor Portes: We rely on the judgments of central bankers in these matters all the time. It is very hard to specify in advance what the nature of any given crisis is going to be. All crises are somewhat different. They may have common roots in many cases but their manifestations are always different: if it is an individual distressed financial institution that can differ quite considerably. I think it would be very difficult, if not impossible, to draw up any specific guidelines for intervention. As I say, central bankers for good or for ill have functioned in that way now since time immemorial.

  Q25  Mr Plaskitt: The envisaged consequence of triggering this is that the Commission, according to the draft wording, can "upon its own initiative" immediately intervene. That is a huge power. In your view, does there not need to be some more definition about what constitutes an adverse development? Lots of things can be an adverse development, but if that is enough to trigger the Commission on its own initiative to make an intervention, is that alright, in your view?

  Professor Portes: What exactly do you mean by "intervention"? You mean declaring that there is a crisis?

  Q26  Mr Plaskitt: No. What Article 10 says is the Commission can on its own initiative adopt a decision, and the next section says that will give it the power to require the competent authority to take a necessary action. It becomes quite direct and quite specific as I read it; and yet it all rests on the development of an "adverse development". Is it not a sweeping opportunity to exercise that power?

  Professor Portes: As I say, I cannot see how you can draw more specific requirements because of the immense diversity. If we look even at the nature of the financial institutions that have gotten into trouble and the things that have gotten them into trouble over the past couple of years the range of possibilities is enormous. I could sit here as an academic—and we academics are known for going into all sorts of "I couldn't possibly speculate"!

  Q27  Mr Plaskitt: How about there being some indication of the potential extent of risk?

  Dr Danielsson: Could I add a little bit to this. I would agree very much with Richard. One problem with financial regulations in general is that they tend to guard against the previous crisis and not against the next one. There is always a danger, if you specify a regulatory structure for monitoring, that a reaction to whatever happened in the past creates inflexibility in dealing with the future. Therefore I think we do need to rely on the judgment of the central bankers to define the sequence and therefore writing them down is not the right way to do it.

  Dr Alexander: I would say that discretion is very important. We do not know what the source of the next financial crisis will be. I think also there is protection in Article 10 because the European Supervisory Authority may take measures to require a competent authority to do something but they have to do that on a qualified majority vote; and then the competent authority, say it is the UK FSA, they can appeal to a board of appeal, so there is a procedure in place. For an emergency there is an expedited procedure for appeal. I do not think it will get to that point. This would be unusually exceptional circumstances. The UK FSA, in their role in influencing the European Supervisory Authority, they are going to be right at the table and I doubt there would be a compulsory determination made against the UK FSA or the regulator.

  Q28  Mr Plaskitt: Do you think there is enough in the draft as it is currently constituted to put in place early warning intervention, so there is intervention before you start hitting emergencies?

  Dr Danielsson: I worry about all these early warning mechanisms. We have been talking about early warning mechanisms in the global financial system for the past 30-40 years and these proposals have been made and none of them seem to work properly. With so many of the systemic events they seem to come out of the blue. After the facts we know what happened, but before the event we cannot identify any specific things that might lead to a future crisis. There is also a danger in having an early warning system like that might lead us to make a decision which is wrong.

  Q29  Mr Plaskitt: Have we been looking for them? One of the arguments is that they were not spotted because no-one was bothering to ask penetrating questions; everyone was just gliding along. Have we not learnt from what has just happened that there ought to be some questions that are periodically being asked? Some stress testing that should be being done on a regular basis, could that not be part of a trigger mechanism for an early warning system?

  Professor Portes: It is not that warnings were not issued by competent international bodies—and that is why I smile when I read paragraph 6.2 in the Impact Statement about the tasks and powers of the SRB; it sounds exactly like the tasks and powers of the IMF or the BIS. We have the Global Financial Stability Report of the IMF every six months, and the BIS Annual Report every year for quite some time was warning of the dangers that were being created in the system, the search for a yield, the excessive risk-taking and so on and so on; but as Dr Danielsson said quite rightly in the event you did not know how that was going to manifest itself. Some of us, myself included, were wrong about the way in which those imbalances would manifest themselves. I wrote that there were serious difficulties but I got it wrong like most of my colleagues in how they would come out. I think that is where with specific early warning—

  Q30  Mr Plaskitt: You are saying there is nothing in here to strengthen early warning systems in the future?

  Professor Portes: As I say, you could write this paragraph 6.2 here and it would apply absolutely to the IMF and the Bank for International Settlements, and they are a reputational body with a high level composition that will point out potential imbalances in the financial system which are likely to increase systemic risk and so on and so forth. That is exactly what the major international organisations did.

  Q31  Mr Plaskitt: Do the other two of you share the same view?

  Dr Alexander: I would say that there is an incremental improvement here. The European Systemic Risk Board will be entitled to obtain information that would have been considered confidential before from national supervisors and that will enable it to conduct, I think, more effective surveillance. Many Member State national supervisors would not disclose information either for proprietary reasons or for other reasons, including embarrassment, to the ECB, and so now we have a framework set up where any national legal restriction on the disclosure of information is going to be amended and Member State supervisors shall share information with the Systemic Risk Board and also the European Supervisory Authorities. I am not going to say that is foolproof prevention for a future crisis but I think that is an important step, to link up macro-prudential oversight with micro-prudential supervision.

  Q32  Mr Love: Dr Alexander, earlier on in an answer to Mr Fallon you indicated that in your view the regulations ensured that the decisions made do not impinge on the fiscal responsibility of Member States. Would you accept that that is not a confidence that others share?

  Dr Alexander: Right now there is no legal requirement that a state bail out a bank because of a decision made by the European Systemic Risk Board. There is no legal obligation to do that in the current proposal, if we are in a crisis, for instance. That would have to be a decision made at ECOFIN and the Council of Ministers as a finance ministry decision, so I just do not share that concern. I think there are other concerns that we might talk about regarding these proposals. Out in the future there could be burden sharing arrangements introduced and agreed to by all Member States regarding how we might respond in a crisis, and that is something that needs to be addressed in the future. Also, how do we bail out cross-border banks that are viewed to be too big to fail? The Commission has now got a consultation paper; last month they proposed on that, so I think these are discussions that we need to keep having in the future but presently there is no legal obligation for a state to use taxpayer money for that.

  Q33  Mr Love: What has been said to us is that there is a safeguard clause related to Articles 10 and 11 but not in relation to Article 21 and therefore it is open that a decision made by the Systemic Risk Board could trigger the need for fiscal intervention in a Member State. Do you not accept that?

  Dr Alexander: The Systemic Risk Board cannot make that decision. They can make a recommendation to ECOFIN and the Council of Ministers, so it goes up the political chain.

  Q34  Mr Love: Let me pose it to you another way. They may make a judgment. That judgment is then leaked. There is then a run on a financial institution that triggers a fiscal intervention. Is that not a possibility, what could happen in any of the circumstances that we are talking about?

  Dr Alexander: The European Systemic Risk Board can issue warnings, recommendations, and these all have to be acted on. They are not legally binding decisions, and that is their role, to point out problems, red flags, certain developments in the financial system. It has no power to compel a Member State to use taxpayer money to bail a bank out or subsidise it directly. It might say that the European supervisory agencies can make decisions that are legally binding by qualified majority voting which may have indirectly a fiscal impact. It might require that supervisors perform more active supervision at the local level which is going to involve taxpayer money probably, certainly indirectly, but regarding a bank bail-out during a crisis, there is nothing legally binding in that area.

  Professor Portes: If you go down that road you might as well try to muzzle Robert Peston, that is to say, yes, anybody saying an institution is in trouble, better do something about it, can provoke a run; that is absolutely standard. There is not much you can do about that. There is no authority here, however. Dr Alexander is perfectly right—there is no authority here and I do not know who is maintaining that there might be some hidden authority. If so, it is hidden awfully well. I just do not believe this. It is quite explicit that there shall be no such powers.

  Q35  Mr Love: Is it appropriate for the Council of Ministers to rule on this issue by qualified majority voting, considering the sensitivities of this as an issue?

  Professor Portes: To rule on what? To rule on imposing fiscal obligations? Again, if we did not like what was being proposed we would invoke the standard safeguard, which is that no external instance by qualified majority voting or any other way can impose a fiscal obligation on the UK Treasury, full stop.

  Q36  Mr Fallon: I just want to come back on this, Professor Portes. Article 23 does not say that. It says that the Council considers an appeal from a Member State and can uphold the Authority's original decision, so the safeguard you are referring to is not in the draft.

  Professor Portes: Not on fiscal obligations. I am sorry, I do not agree; I certainly do not read it that way, and there are enough explicit provisions in there that say that none of these new instances can impose fiscal obligations on Member States.

  Q37  Mr Fallon: But Article 23(2) says, "Where the Council by majority voting decides to maintain the Authority's decision ... the suspension of that decision shall be immediately terminated".

  Professor Portes: Decision on what?

  Q38  Mr Fallon: A decision that a Member State appeals as in terms of its fiscal responsibilities.

  Professor Portes: No, I am sorry. I do not have that passage in front of me.

  Q39  Mr Fallon: Have you read Article 23?

  Professor Portes: Closely, and I cannot see any room for that interpretation.

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