Memorandum from the London Investment
1. LIBA is the principal trade association
in the United Kingdom for firms which are active in the investment
banking and securities industry. Its objective is to ensure that
London continues to be an attractive location for the conduct
of investment banking business.
2. We comment only on the second part of
the inquiry's Terms of Reference: Potential reforms to the international
financial regulatory system. Our main points are as follows:
(a) The principle of a European Systemic Risk
Council, thoroughly integrated with global systemic risk arrangements,
is a good one, but it needs to be better balanced to ensure a
full and rounded assessment of risk.
(b) The Commission and de Larosie"re are
right to stress the need for urgent improvements to the quality
of EU regulation and supervision, and coordination between national
authorities. These improvements need to be made before any move
is made to centralise powers at EU level.
(c) The proposed establishment of an EU authority
to fulfil certain tasks needs to be carefully considered to ensure
that it contributes to the quality of regulation and coordination.
In particular, any decisions about it need to be based on more
precision about how it would operate, and on what basis it would
assume powers from national authorities.
(d) Defining characteristics of any EU authority
need to be set so that the quality of its work can be assured.
(e) The implications of financial turmoil for
risk management in the single market will need to be carefully
considered, and any limitation of passporting rights kept to a
(f) The London Summit set out the right basis
for global coordination of standard-setting and supervisory cooperation.
Regional and national policy-making needs to be in line with and
not front-run the global consensus.
(g) Colleges are the right mechanism to build
international coordination of supervision. To be efficient and
effective, it will be important for EU arrangements on supervisory
cooperation arrangements to mesh well with global colleges.
3. Current initiatives to improve EU financial
regulation and supervisory cooperation are part of a continuing
process that has been going on for many years. Although many of
the current initiatives have been prompted by the financial turmoil,
they are not qualitatively different from the continuing drive
over many years to improve and streamline EU rules and supervision,
aspects of which include: the mid-2000s Financial Services Action
Plan (FSAP) to modernise financial services single market legislation;
the parallel development of the CRD to introduce the Basel 2 improvements
to the prudential framework; the early 2000s introduction of the
Lamfalussy process to improve the technical quality of EU legislation
and to provide a formal structure for regulatory and supervisory
convergence and cooperation; and a series of reviews and recommendations
for improvements to those cooperation arrangements, culminating
in the 2007 and 2008 ECOFIN action plans that arose from the review
of the Lamfalussy process. However, unlike the FSAP which sought
to produce deep liquid capital markets for the benefit of corporate
Europe, there is no clearly defined similar vision covering current
regulatory and supervisory initiatives.
4. In addition to a range of specific policy
proposals that broadly align with work that is already in progress
or planned at global level under the aegis of the Financial Stability
Forum / Financial Stability Board (see below), the European Commission's
Communication "Driving European Recovery" and the de
Larosie"re report make a range of proposals for structural
changes to arrangements for supervisory and financial stability
cooperation within the EEA.
5. The Commission Communication and de Larosie"re
report propose to establish a new European Systemic Risk Council
(ESRC) to provide a formal structure to gather information about
and assess potential financial stability risks, and to initiate
a reaction from responsible authorities. de Larosie"re highlights
the need for the ESRC to interact effectively with global systemic
risk analysis arrangements coordinated through the IMF and FSB,
as agreed by the London Summit. This is indeed a vital link, since
an analysis of systemic risk based on the EU alone is unlikely
to be comprehensive, and ignoring the interaction with the rest
of the world could lead to false and misleading conclusions. There
also needs to be an appropriate and effective mechanism for translating
the ESRC's assessments into, at national supervisory level, either
action or a valid explanation of why action is not appropriate.
6. The Commission Communication and de Larosie"re
report propose that the ESRC be largely a central banking body.
To be fully effectivein gathering information, analysing
the interaction between different markets, and giving effect to
its decisions participation in the ESRC needs full participation
by supervisors as well as central banks, both eurozone and non-eurozone,
and to involve also the authorities overseeing securities markets
and insurance, as well as banking.
7. The de Larosie"re Report proposes
to reinforce the existing Lamfalussy arrangements with a European
System of Financial Supervisors (ESFS), introduced in stages.
8. Stage 1 of the ESFS, which fits well
with work in progress under the ECOFIN road maps, involves a series
of urgently needed improvements to existing arrangements for EU
regulatory and supervisory cooperation. These improvements of
EU supervision and supervisory cooperation arrangements need to
be undertaken carefully, and to take account of developments in
other jurisdictions as the London Summit action plan is developed.
9. Amongst the critical steps that need
to be taken, some of which (in particular aspects of (b), (c),
and (d) are referred to in the Commission's and de Larosie"re's
(a) Global and EU agreement of defined public
policy outcomes that regulation aims to achieve. The EU should
avoid pre empting Global agreements.
(b) Ensuring that regulatory staff have the right
skill sets and detailed knowledge and understanding of different
markets. This is important for all markets, including retail,
wholesale and corporate markets, but particularly for effective
regulation and supervision of wholesale markets. The ability to
trust the quality of supervisors across all EU jurisdictions is
a sine qua non if the single market is to reach its full potential.
(c) Ensuring that colleges established under
EU arrangements (see below) are consistent with, and interact
smoothly and seamlessly with international colleges, on the basis
of globally agreed guidelines, working flexibly to enable key
supervisors to discuss strategy, and all relevant authorities
to exchange information and coordinate supervision, accommodating
third country and EU supervisory authorities as appropriate, and
ensuring that the confidentiality of information provided through
global college arrangements is respected in interactions between
(d) Full and consistent implementation by Member
States of the harmonised core rules set out in EU legislation.
(e) Analysis of what degree of convergence is
appropriate in different supervisory tasks, and how far supervisory
flexibility is valid or necessary, recognising that the optimal
level of integration may need to differ in different areas.
(f) Resolution of fiscal support issues in a
way that ensures alignment between regulatory and supervisory
decision-making and responsibility for fiscal support and the
lender of last resort function: without resolution of the fiscal
issue, it is hard to envisage successful centralisation of supervisory
10. The de Larosie"re Report then proposes
a Stage 2, to be commenced in 2011, under which new EU agencies
with enhanced powers would take over certain regulatory and supervisory
functions of the Level 3 Committees and national authorities,
and apply them in a strengthened and more mandated way.
11. One of the main deficiencies in both
the Commission Communication and the de Larosie"re report
is that they are not precise about how they propose the existing
arrangements and allocation of powers would be adjusted. Instead
they refer vaguely to the proposed EU authority exercising "binding
supervisory standards", "binding mediation" of
disputes between regulators, and binding standards for the operation
of colleges. The Commission is expected to publish a further Communication
in May which may include more specific proposals.
12. In an attempt to introduce more precision,
and to demarcate the boundary between national prerogatives and
areas where an EU-level authority would be beneficial, the UK
government and FSA have proposed, through the Chancellor of the
Exchequer's 3rd March letter to the Presidency of the Council,
and the Turner Review and Discussion Paper 09/2 respectively,
a scheme under which an EU-level authority would have the power
to set binding rules, but all supervisory activities and decision-making
would remain at national level, with colleges being used to coordinate
and streamline supervisory activity at both EU and global level.
13. Until there is more clarity and certainty
about what precise interaction is proposed between EU and national
responsibilities and prerogatives, and how it would affect coordination
at global level, it is difficult to assess whether any particular
model would improve regulatory and supervisory coordination. It
is, however, vital that any adjustments to the structure of EU
regulation and supervision build on and continue the quality improvements
in Stage 1. We have suggested to the Commission a series of defining
characteristics which any EU authority would need to have to ensure
that it maintained and improved the high quality that is needed
to oversee wholesale securities markets. They would need to be
clearly established, in the constitution and working procedures
of any EU authority, at the outset.
(a) Governance: Explicit attention to the wholesale
and global character of cross-border markets; ensure that all
those who are interested in what the authority does can have their
voice heard; specification of who it is answerable to; specification
in advance of how the quality of its performance will be measured,
and what sanctions will be available if it fails.
(b) Scope: Clear demarcation of boundaries of
competence between the EU authority and national authorities,
in particular as regards: scope for differential implementation
of an agreed regulatory outcome; national autonomy over supervisory
approaches, technical decisions, and issues not harmonised at
EU level, use of comply or explain procedures. This demarcation
needs to dovetail with fiscal responsibility.
(c) Regulatory philosophy: Outcome-focused regulatory
approach, based on agreed public policy needs.
(d) Regulatory process: Effective regulation
disciplines, including market failure analysis, impact analysis,
and cost-benefit analysis, diligent consultation, and genuine
dialogue with regulated entities and other interested parties,
as standard procedure.
(e) Quality of staffing: Technically expert and
market-aware governing council and staff; alert and rapidly responsive
to market developments.
(f) Quality control: Analogous to Level 4 (with
EC cooperation where necessary) to achieve consistent effective
implementation of EU legislation.
(g) Differentiated regulation: Explicit acknowledgement
of, and attention to, different needs of different markets and
sectors: banking / securities and derivatives / infrastructure
/ insurance; wholesale / retail; different supervisory tasks:
prudential (various) / conduct of business / market; in each case,
specification of what is the scope of the EU authority's / authorities'
responsibility (which might differ from one sector or task to
(h) Location: Proximate to the EU's key global
markets, so that it can have close interaction and dialogue with
them, and draw on strong pools of technical talent.
IN (EU) EUROPEAN
14. Home country supervision is premised
on the fact that a financial institution which has branches in
other Member States will be subject to supervisory and administrative
decisions made in the Home Member State but which are based on
minimum harmonised standards set out in EU legislation: this reflects
basic Treaty principles. When an authorised financial services
firm branches into a different Member State, the Host State has
few if any rights to object or prevent the branching. It is important
to understand that to amend this treatment would be to question
the fundamental premise of the EU Single Market. The Turner Review
raises questions about branch passporting in the particular context
of the problems that arose in retail deposit-taking. It is important
that any restrictions on existing passporting freedoms be proportionate
to the problems identified and not, for example, extended beyond
the special circumstances of retail deposit-taking to other business
areas without separate justification. Under EU legislation host
supervisors have emergency powers, but some have argued that the
ability to exercise those powers may come too late to affect the
outcome. There needs to a be a full discussion of rights and responsibilities
in the context of the specific problems identified when assessing
the more difficult and costly outcomes that can be faced in a
crisis. The Turner Review says that we have a half-way house at
present, and that we may need either "more Europe" or
"less Europe". The complexity of the topic means, however,
that the right approach is likely to be more nuanced than a simple
choice between concentrating powers either in the host supervisor
or in EU authorities. However, as indicated above, it will be
particularly important to consider, at least in the "less
Europe" context, a proportionate response which appropriately
distinguishes between different sectors of the market, and restricts
existing passporting freedoms as little as possible, consistent
with systemic risk management.
15. The 2 April 2009 London Summit's Global
Plan for Recovery and Reform and the Summit's Declaration on Strengthening
the Financial System set the agenda for improvements to global
regulation to be made on a consistent basis through global standard
setters such as the Basel Committee on Banking Supervision and
International Organisation of Securities Commissions (IOSCO),
coordinated by the re-constituted and expanded Financial Stability
Board. These initiatives will need to build on the considerable
policy improvements that have already been in progress for well
over a year under the aegis of the Financial Stability Forum.
16. In all these contexts, it is important
for policy makers to take account of the steps that market participants
have themselves taken to reduce or manage risk and to improve
the operation of markets, in particular in the securitisation
and credit default swap markets. Further developments need to
continue to be made in dialogue with market participants, applying
thoroughly the disciplines of effective regulation, including
market failure analysis, impact analysis, cost-benefit analysis,
and consultation. The fact that failures have occurred does not
negate the principle that new requirements must be determined
in accordance with due process.
17. Once global standards have been established,
it is important that national and regional authorities fulfil
the commitments in the London Summit communiqués to streamline
rules with the global consensus. This may necessitate adjusting
EU or UK rules that have been or may be put in place in several
areasincluding the capital treatment of securitisations
and re-securitisations; regulation of liquidity; and regulation
of credit rating agenciesahead of, and in some cases diverging
from, the global consensus.
18. Colleges have long been used as the
mechanism for global supervisory cooperation. The London Summit's
and EU's current focus on colleges is thus a development
and formalisation of existing policy, not the creation
of a new policy. When discussing colleges, it is important to
be clear about use of terms, and to distinguish in particular
between two different uses of the word `college' at global and
EU level, eliminate the scope for duplication and conflict between
them, and avoid the consequent increase in risk.
19. In the global context "college"
is commonly used to refer to a grouping of supervisors, who do
not share a common legal framework, exchanging information and
possibly agreeing coordination, on the basis of memoranda of understanding,
but with no legal commitment and no interference in the rights
and obligations of national supervisors. This is a flexible structure
that allows variation depending on the differences in how different
groups are constituted, or the differing focus of their business
and their supervisors' priorities. The London Summit confirmed
these colleges as the basis for global cooperation, under the
guidance of the Financial Stability Board, in supervising the
major transnational firms.
20. Some commentators have criticised colleges
for being ineffective, or because they do not provide a firm enough
legal basis for decisive cooperation. In the EU context, for example
in the Capital Requirements Directive, and the de Larosie"re
Report, the term "college" has been coopted to refer
to a more structured interaction between supervisors, based on
EU law, with a stronger and more mandatory directing and coordinating
role for the consolidating supervisor.
21. It is clearly important to use EU legislation
to the extent possible and appropriate to align EU requirements
and streamline supervision by giving responsibilities and tasks
that cover the whole group to the consolidating supervisor of
the parent EU entity. It is also important to ensure that arrangements
for group supervision within the EU are adaptable enough to reconcile
the need for supervisory efficiency with the legitimate interests
of Member States, including the Lender of Last Resort responsibilities
which attach specifically to national authorities. To a significant
degree Group Supervision is already in place in the EU as there
are already consolidated supervision requirements and a number
of supervisory arrangements to deal with group structures that
include multiple subsidiaries within the EU. But the treatment
of a group will be very different depending on whether, for example
(i) all subsidiaries are owned by a single holding company within
the EU; or (ii) multiple subsidiaries within the EU are owned
by a parent outside the EU. Even in the first case, the subsidiaries
of EU companies that are incorporated outside the EU could not
be brought within a single group supervisor model. It is necessary
in all cases to balance the legitimate interests of national supervisors
with the need for streamlined supervision, and the public policy
need for efficient, effective, and well-coordinated group supervision,
taking account of the global as well as the EU dimension. The
most appropriate arrangements may differ in different supervisory
fields: it is therefore important to ensure that any "unified"
system of supervision across borders is not also a "rigid"
system that diminishes effectiveness or impedes cooperation with
22. All major cross-border groups are global,
and agreements on cooperation between sovereign authorities necessarily
rely heavily on political commitments rather than the force of
law. Equally it is clear that there is no legal framework that
can apply to all jurisdictions. Much experience in the operation
of global colleges has been gained in recent years which can now
be used to improve the operation of colleges. The political impetus
to international cooperation in the wake of the financial turmoil
provides a context in which necessary further improvements can
be pursued strongly.
23. To be effective EU arrangements need
to take account of the global dimension. It would be duplicative,
inefficient, and risky to seek to force EU and global colleges
to operate separately. Binding EU requirements cannot, by definition,
apply to non-EU authorities, so it is difficult in practice to
envisage how direct EU oversight of and intervention in global
colleges, on the model that the Commission Communication and de
Larosie"re Report envisage, could be compatible with international
cooperation. To be effective, policy in the EU and elsewhere must
focus on treating global colleges, under the aegis of the FSB
as agreed by the London Summit, as the prime forum for international
supervisory cooperation, separately from the use of EU legislation
and supervisory coordination to align supervisory practice in
the EU sub-group.
24. We would be grateful if the Committee
would consider including in its report the points listed in paragraph