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


Supplementary written evidence submitted by Dr Kern Alexander

  The Commission's proposed regulations will lead to significant institutional consolidation of European financial supervision and macro-prudential oversight. The creation of a European Systemic Risk Board (ESRB) would enhance EU member states's capacity to assess and monitor the level of systemic risk in European financial systems and to obtain data on large systemic financial institutions and other financial market information from member state supervisors. The creation of a European System of Financial Supervisors would bring important changes to the operations and functions of the three Level 3 Lamfalussy Committees by creating three new European supervisory agencies with legal authority to ensure consistent application of EU financial legislation. The proposed regulation for a European Systemic Risk Board would allow the ESRB to obtain data and other information from micro-prudential supervisors in order to assess the level of risk in European financial markets.

IDENTIFYING SYSTEMIC RISK IN EUROPEAN FINANCIAL SYSTEMS

  Oral evidence was presented to the Treasury Committee on 3 November 2009 that there is inadequate understanding of the causes of systemic risk in financial markets and that the proposed Regulation for a European Systemic Risk Board (ESRB) does not provide any information on what systemic risk means and how to measure it. Accordingly, it was argued that the design of the ESRB is flawed and should be substantially revised. In addressing this concern, it is submitted that although systemic risk is difficult to measure, and its causes are even more difficult to identify precisely (especially for a future financial crisis), EU policymakers should not conclude therefore that they should not try to establish institutional frameworks to monitor systemic risks across EU financial markets. Indeed, the financial crisis demonstrates that macro-prudential risks are evident in the European financial system.[27] Banks have exposure to each other throughout Europe in the money markets through a variety of risk exposures, and European policy-making needs to have better surveillance of the systemic risks posed by certain banking groups and financial institutions that operate in Europe. The crisis also demonstrates that systemic risk arises in the wholesale capital markets—especially through the securitisation and the over-the-counter credit default swap markets—as well as from individual financial institutions. The Turner Review recognised that the sources of systemic risk can be macro-prudential in nature and that this necessitates that central banks and regulators establish enhanced cross-border (international and European) frameworks for identifying and monitoring macro-prudential systemic risks and, in certain circumstances, for issuing early warnings to affected countries. The absence of a consensus view on the sources of systemic risk therefore does not preclude the design of effective cross-border institutional structures to monitor and measure systemic risks in European financial markets.

  The Commission's proposals are premised on the notion that current supervisory arrangements proved incapable of preventing, managing and resolving the recent financial crisis. Moreover, following the Turner Review, the Commission has observed that cross-border macro-prudential risk assessment was inadequate prior to the financial crisis and that more effective cross-border monitoring of system-wide risks and financial supervision are needed to promote the Treaty objectives of the internal market. The proposed regulation to establish the ESRB with the objective of enhancing cross-border macro-prudential surveillance and oversight of European financial markets should be a welcome public policy objective.

THE URGENCY OF THE PROPOSALS AND SHORT PERIOD FOR CONSIDERATION

  It should be recalled that consideration of the creation of these types of bodies began on 25 February 2009 when the De Larosie"re group presented its report making recommendations to create a European Systemic Risk Council and European System of Financial Supervisors. Building on these recommendations, the Commission issued a Communication on 4 March 2009 setting forth its proposals for a new European supervisory framework. Following this, the Communication embarked on a consultation from 10 March to 10 April which contributed to another Communication on Financial Supervision issued on 27 May 2009 which in turn led to another consultation from 27 May to 15 July. The latter consultation led to a number of responses that were largely supportive of the proposed reforms while making detailed and constructively critical comments on key aspects of the proposed ESRB and ESFS. The consultation was followed by two impact assessments in May and October.

  These communications, consultations and impact study were followed by the Commission's proposal on 23 September 2009 for a Council Decision to establish a European Systemic Risk Board (ESRB) and a European System of Financial Supervisors (ESFS) along with separate proposals for a European Banking Authority, European Securities and Markets Authority (ESMA), and European Insurance and Occupational Pensions Authority (EIOPA). ECOFIN will consider these proposals on 3 December and the Council of Ministers will vote on their adoption into Community law on 10 December 2009. The short period in which these proposals are being considered reflects the urgency of the financial crisis and its immediate aftermath and the economic necessity of adopting institutional and legal reforms while the political climate supports the necessity of regulatory and supervisory reforms.

EUROPEAN SYSTEMIC RISK BOARD

The General Board and Voting

  During oral evidence, Committee members raised the concern that non-eurozone central banks and Finance Ministers did not have adequate representation on the ESRB. Article 6 of the ESRB Regulation[28] states that the members of the ESRB General Board with voting rights shall be: the President and Vice-President of the ECB; the Governors of the national central banks; a Member of the European Commission; the Chairperson of the European Banking Authority; the Chairperson of the European Insurance and Occupational Pensions Authority; and the Chairperson of the European Securities Markets Authority.[29] The General Board shall take the decisions necessary to ensure that the ESRB performs the tasks entrusted to it.[30] Each member of the General Board with voting rights shall have one vote each. The General Board shall act by simple majority vote of Members present with voting rights.[31] This means that representatives of central banks from all EU states will be able to exercise one vote per representative in making the decisions that govern the ESRB.

  The ESRB, however, provides a voting advantage to eurozone member states by requiring that the vote of the General Board to elect the Chair and the Vice Chair of the ESRB can only be taken by members of the General Board who are also members of the General Council of the European Central Bank. This means that the ECB General Council will control the voting for the Chair and Vice Chair of the ESRB. However, the members of the ECB General Council who vote for the Chair and Vice Chair of the ESRB could potentially vote for central bank governors or regulators or other officials from countries not in the eurozone. For instance, these Board members could vote for the Chair and/or the Vice Chair of the ESRB to be an official from a central bank or regulatory authority from a non-eurozone EU state. Nevertheless, there is a legitimate concern that because the election of the Chair and Vice Chair is controlled by ESRB board members who are also ECB General Council members that this will lead to a disproportionate influence of eurozone representatives electing the Chair and Vice Chair and thus undermine the accountability and legitimacy of the ESRB governance structure.

  The Treasury Committee should therefore consider an amendment to the ESRB Regulation that allows non-eurozone representative members of the ESRB General Board to vote for the Chair and Vice Chair of the ESRB General Board. This would create more balance in the governing structure of the ESRB without undermining the effectiveness of the European Central Bank in providing secretariat and other administrative support to the ESRB's operations.

  Similarly, the ESRB Steering Committee is disproportionately influenced by representatives from the eurozone countries. The Steering Committee will have 12 members consisting of the Chair and Vice Chair of the ESRB and "five other members of the General Board who are also members of the General Council of the ECB."[32] The five members of the General Board who are elected to the Steering Committee can only be elected by members of the ESRB General Board "who are also members of the General Council of the ECB for a period of two years."[33] The accountability and legitimacy of the Steering Committee would therefore be enhanced if members of the ESRB General Board who were not members of the ECB Governing Council could also vote for the five members of the ESRB Steering Committee.

THE LEGALLY BINDING NATURE OF ESA DECISIONS AND THE FISCAL AUTHORITY OF STATES

  Treasury Committee members raised concerns about the powers of the European Supervisory Authorities to issue directives that might infringe on the fiscal responsibilities of member state governments. For example, article 11 of the ESA regulations provides ESAs with the authority to settle disagreements between national authorities where the disputes involve procedural co-ordination or joint decision-making between authorities in the colleges of supervisors. At the request of a national supervisory authority or of the Commission, the ESAs can assist national supervisory authorities in following a common approach with respect to co-operation or co-ordination or other procedural decision-making between supervisors (ie decision-making in the colleges of supervisors). In case of a dispute between supervisors, the ESA can settle the dispute and, in doing so, must follow a procedure consisting of three steps:

    1. If one or more supervisory authorities request ESA to assist in resolving disagreements, it may require conciliation between the authorities with the ESA involved if necessary in a mediatory capacity.

    2. If there is no resolution after conciliation, the ESA may through a decision settle the matter. However, this would clearly be exceptional, as most authorities would normally reach agreement in conciliation.

    3. Where a national authority has not complied with a ESA's decision, the

ESA may also decide to adopt decisions addressed to financial institutions specifying their obligations in respect of Community law if the financial institution is based in the member state in breach of the ESA decision.

  For a dispute under article 11, the fiscal safeguard provision of Article 23 provides that no resolution of a disagreement by the ESA between the national authority and/or financial institution concerned can infringe on the fiscal responsibility of the member state concerned. The member state authority or financial institution concerned can appeal an ESA ruling regarding fiscal responsibility to Council which then has two months to decide the appeal.

  It should also be emphasised that a national supervisory authority or financial institution subject to an adverse decision of an ESA under articles 9, 10, and 11 and any other decision taken by the Authority according to legislation designated in the Regulation can appeal the ESA's decision to the ESA Board of Appeal[34] and, if unsuccessful, can bring an action before the Court of First Instance of the European Communities.[35]

  In addition, regarding ESA emergency directives to a national authority during a financial crisis or similar period of declared disorderly markets, Article 10 provides that the ESAs shall fulfil an active co-ordination role between national authorities during adverse market developments in the EU financial system.[36] In some cases, co-ordination may not be sufficient, in which case ESAs would have the power to require national supervisors to take specific action. If a state authority believes that such action infringes on its fiscal responsibilities as provided in Article 23 of the Regulation, the state may appeal the ESA's directive on an expedited basis to the Council of Ministers.[37]

  Specifically, Article 23 (1) provides that no decision adopted under Article 10 or 11 can impinge "in any way on the fiscal responsibilities of Member States." This safeguard clause applies only to situations where the ESA or Commission have made determinations regarding co-operation or co-ordination of supervisory practices between member states with respect to the functioning of the colleges of supervisors and related home-host state procedural matters (art 11) and any emergency co-ordination to be taken during a financial crisis or disorderly markets (art 10).

  The fiscal safeguard, however, does not apply to matters or disputes falling under Article 9 because this article deals with pre-existing obligations of Community law as set forth in designated EU financial directives and provides a mechanism for ESAs to ensure that technical standards are implemented in a coherent way without derogations to ensure the harmonised application of EC legislation.[38] Nevertheless, any decision taken by an ESA under articles 9, 10 and 11 or any other decision taken according to legislation referred to in Article 1(2) of the Regulation can be appealed to the Board of Appeal[39] and, if the appeal fails, bring an action to the Court of First Instance of the European Communities.[40]

  Article 9 addresses the role of the ESA in ensuring compliance with the substantive standards of Community law with respect to Community legislation listed in Article 1(2) of the Regulation.[41] The ESAs will have authority to ensure the consistent application of Community law as set forth in the relevant directives. The ESA will adopt a rulebook or code that provides harmonised core standards that cannot be derogated from. These technical standards are designed to enhance the effectiveness of Level 3 of the Lamfalussy guidelines which have been legally non-binding The ESAs can adopt the draft technical standards by a qualified majority vote of the ESA Boards of Supervisors. The draft technical standards would then have to be adopted by the Commission to become Community law. In exceptional circumstances, the Commission could decide to adopt, or not, the standards, in part or in whole with amendments.

  The ESAs would have the authority to resolve differences in member state application of standards and to ensure that national supervisors' rules and practices do not diverge from existing Community legislation (including technical standards). This supports the ESAs general power under the Regulations to ensure coherent application of Community legislation. It can exercise this authority though three steps:

    1. ESA would, sua sponte, or at recommendation of other supervisor or Commission, would investigate cases of alleged violation of technical standards or related breach of Community legislation and adopt a recommendation for action by the designated national authority. The supervisory authority would then have 1 month to comply.

    2. if recommendation not complied with, the Commission may, after being informed by ESA or on its own initiative, take a decision requiring the national authority to take either specific action or refrain from action. The national; supervisor to whom measures directed shall within 10 days of receipt of the decision inform the Commission and ESA of the steps it has taken—or intends to take—to implement the decision.

    3. In exceptional circumstance, where the supervisory authority concerned does not comply, the ESA may as a last resort adopt a decision addressed to financial institutions in respect to Community law which is directly applicable to them (ie Regulations).

  The Article 23 fiscal safeguard provisions do not apply here because it deals with substantive requirements of existing Community legislation designated in the Regulation.[42] These obligations do not involve additional direct fiscal obligations of member states, such as bailing a bank out in a financial crisis.

ESRB ADVISORY ROLE TO EU SUPERVISORS

  The ESRB's role will be to monitor system-wide risk in European financial markets and to issue warnings and recommendations to EU member state authorities and ESAs regarding systemic risk in financial markets. These warnings and recommendations are legally-non-binding, but will likely influence the European Supervisory Authorities in overseeing the supervisory practices of member state regulators. ESAs have a legal obligation to "take the utmost account of the warnings and recommendations of the ESRB." For example, Article 21 of the European Banking Authority Regulation provides that the European Banking Authority shall co-operate closely with the ESRB. The ESAs shall provide the ESRB with regular and up-to-date information. Significantly, the ESA shall convene a meeting of the ESA Board of Supervisors when ESRB has issued a warning or recommendation to the ESA or a member state authority. The ESA Board shall decide by qualified majority voting what action it should take regarding an ESRB recommendation or warning. If the ESA votes not to take action, it shall inform the ESRB with an explanation.

  Where a member state authority decides not to follow the recommendation of the ESRB, it shall inform the relevant ESA Board of Supervisors of its reasons not to do so.[43] Where an ESA, by qualified majority vote, decides to order a member state authority to take certain actions and such actions are authorised by the powers granted to the ESA in its regulations, the member state may be compelled to act in order to comply with the ESA's order to take "actions in accordance with the powers conferred upon it by this Regulation for addressing the issues identified in the warnings or recommendations." As discussed below, a member state authority could contest such an order through appeal to the Board of Appeal and by action to the Court of First Instance of the European Communities.

  Treasury Committee members expressed a concern that this might lead to a member state authority being ordered to take an action that might infringe on its fiscal autonomy (ie taxpayer bailout of a large bank). It should be noted however that the ESA would only have the authority to order an action that derives from powers it expressly has in the European Banking Authority Regulations, which means that such powers could only be exercised to compel a member authority to comply with an order that was based on pre-existing obligations which the state already had to implement European legislation that was expressly designated in the Regulation. Nevertheless, the concern that the fiscal safeguards provisions of Article 23 only apply to the ESA powers exercised in articles 10 and 11, and not to other articles such as article 21, is well-taken. The minor amendments to article 21 should therefore be made to make it clear that a member state authority would not be compelled to take fiscal measures to comply with a ESA order under article 21 and that accordingly the fiscal safeguards measure of article 23 should apply.

UK REGULATION AND THE CITY'S INTERNATIONAL INFLUENCE

  The causes of the crisis have been attributed to macroeconomic factors, major weaknesses in corporate governance in financial institutions, and serious regulatory failings. The costs of the crisis for the UK economy have been enormous, with recent estimates of more than 19% of UK GDP. It is evident that poorly regulated financial markets can lead to huge social costs for the broader economy and that these social costs in regional and globalised markets can be exported to other economies. The UK is a member of the European Union's internal market with free capital flows and cross-border trade in financial services. The crisis demonstrates that London's important position as an international financial centre brings both economic benefits and social costs to the European economy.[44] It is essential therefore that Europe have a more comprehensive framework for regulating and controlling the social costs of financial risk-taking, especially the systemic risks by weak UK regulation and poor corporate governance at UK banks and financial firms that together destabilised EU financial markets and which contributed significantly to Europe's economic recession.

  The proposed EU Regulations for an ESRB and ESFS complement the trend in UK financial regulation and policy as reflected in recent FSA initiatives to adopt more intrusive regulation on the financial sector that attempts to control the social costs of financial risk-taking and which will lead to stronger and more robust economic growth and development. The Commission's adoption of the Regulations creating the ESRB and ESFS has the objective of enhancing the monitoring and control of systemic risks in the European financial system. It is for this reason that UK policymakers should support these important regulatory initiatives.

9 November 2009









27   See "Financial Supervision and Crisis Management in the EU" (December 2007) K Alexander, J Eatwell, A Persaud and R Reoch, Commissioned Report for the European Parliament Committee on Economic and Monetary Affairs pp 2-3, 17-18. Back

28   Regulation of the European Parliament and of the Council on Community macro-prudential oversight of the financial system and establishing a European Systemic Risk Board, art 6. Back

29   Art 1(a)-(f). Back

30   Art 4(2). Back

31   Art 10(2). Also, a quorum of two-thirds of the member with voting rights is needed for any vote to be taken by the General Board. Back

32   Art 11(1)(a)-(h). Back

33   Art 11(c). Back

34   See Regulation of the European Parliament and of the Council establishing a European Banking Authority, art 46(1)-(7). Back

35   Art 47 (1)-(3). Back

36   The Commission will have the authority to make a determination of a cross-border emergency or adverse market conditions. Art 10(2). Back

37   Art 23(3). Member states can appeal an adverse decision by the Commission or ESA that might infringe on their fiscal responsibilities to the Council of Ministers. Back

38   Essentially, the fiscal safeguard clause in Article 23 is inapplicable for ensuring that member states comply with Article 9 because this article requires compliance with European legislation that has already been adopted into law by member states and for which member states are required to comply with, notwithstanding the possibility that such compliance might result in indirect fiscal expenditures. Back

39   Art 46(1). Back

40   Art 47(1). Back

41   The applicable EC legislation under the European Banking Authority Regulation is: Directive 2006/48/EC, Directive 2006/49/EC, Directive 2002/87/EC, Directive 2005/60/EC, Directive 2002/65/EC and Directive 94/19/EC, including all directives and regulations and decisions based on these acts. Back

42   As with other provisions of the ESA regulations, a member state competent authority or financial institution subject to a directive can appeal any decision of the ESA "referred to in Articles 9, 10, and 11 and any other decision taken by the Authority according to legislation as referred to in" the Regulation. See Regulation of the European Parliament and of the Council establishing a European Banking Authority, art 46(1). Back

43   Art 21(5). Back

44   For example, the collapse of the Royal Bank of Scotland demonstrated how the risk-taking of UK banks can generate cross-border externalities to other countries and financial systems. Back


 
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