Banking Crisis: International Dimensions - Treasury Contents

Memorandum from the London Investment Banking Association

  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 minimum.

    (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 effective—in 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 proposals, are:

    (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 EU supervisors.

    (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 powers.

  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 another).

    (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.


  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 areas—including the capital treatment of securitisations and re-securitisations; regulation of liquidity; and regulation of credit rating agencies—ahead 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 certain countries.

  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 2(a)-(g) above.

May 2009

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