House of Commons - Financial Regulation: a preliminary consideration of the Government's proposals

Financial Regulation: a preliminary consideration of the Government's proposals - Treasury Contents

7 International regulation

International Initiatives

149. In the summary of responses to the consultation, the Government notes that one of the strongest themes emerging was "the importance of the European and international agenda, both during the transition phase and in steady state."[133] While the initial consultation acknowledged this, it was extremely thin on the way in which the United Kingdom would influence such regulation, both in the EU, and in wider spheres.

150. This is an extremely important issue. For example, FPC measures to contain credit growth by increasing banks' minimum capital ratios would be ineffective if foreign banks simply filled the gap. Rules set at international level can also have an effect on individual firm supervision. Effective participation in international regulation is both a central part of macro-prudential policy and key to ensuring that micro-prudential policy can be conducted effectively.

151. At the global level, the G20 has taken a lead, producing broad principles which are now being worked through by the Financial Stability Committee. The topics under consideration include:

Building high quality capital and liquidity standards and mitigating procyclicality;
Reforming compensation practices to support financial stability;
Improving over-the-counter derivatives markets;
Addressing systemically important financial institutions and cross-border resolutions;
Strengthening adherence to international supervisory and regulatory standards.
Strengthening accounting standards .

152. The detailed work on the new capital and liquidity standards for the banks is being conducted by the Basel Committee on Banking Supervision. It is working on "Basel III":

a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector. These measures aim to:

improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source
improve risk management and governance
strengthen banks' transparency and disclosures.

The reforms target:

bank-level, or microprudential, regulation, which will help raise the resilience of individual banking institutions to periods of stress.
Macro-prudential, system wide risks that can build up across the banking sector as well as the procyclical amplification of these risks over time.[134]

European regulation

153. At the same time as this work is being done, the European Union has established a new regulatory structure consisting of three 'supervisory authorities', a banking regulator, the EBA, an insurance and pension regulator, the EIOPA, a markets regulator, and the ESMA. In addition the European Systemic Risk Board (ESRB), composed largely of representatives of the central banks, will monitor and report on systemic risk across Europe.

154. The previous Treasury Committee reported on this in November 2009.[135] The new system came into effect on 1 January 2011. The ESRB recently held its first meeting; it is chaired by Mr Trichet of the European Central Bank, and the Governor of the Bank of England is the Deputy. The chairs and vice chairs of the supervisory authorities have been elected, but there has been no announcement as yet about their Executive Directors.

155. The ESRB will have power to report on financial stability and make recommendations. The three supervisory authorities will be responsible for:

Developing a 'single European rule book' through drafting draft technical standards, which will then be adopted by the European Commission as EU law.
issuing guidance and recommendations with which national supervisors and firms must make every effort to comply.
Investigating cases where a national supervisory authority is failing to apply EU law properly;
providing EU-wide coordination in a crisis. If an emergency is declared, the ESAs may make decisions that are binding on national supervisors and on firms. However, these would be subject to certain conditions and would be limited to ensuring compliance with EU law.
mediating where national supervisory authorities disagree, if necessary making a decision that is binding on both parties to ensure compliance with EU law.[136]

156. In addition to the creation of the new European authorities, there is an ambitious legislative programme taking place at the European level. Commissioner Barnier supplied us with a list of 39 initiatives, the majority of which were legislative proposals. Although in oral evidence the Commissioner had assured us that "my agenda is essentially the G20 agenda"[137], this list indicated that only 14 of these initiatives were directly related to that agenda.

157. Mr David Benson of Nomura emphasised the need to avoid regulatory arbitrage, and the part that EU regulation could play in this:

There is no question but that we need a consistent frame for regulation. So in that context, it's appropriate that the EU should try to establish that consistency across Europe, and it needs to influence the rest of the world, otherwise we'll have regulatory arbitrage, which we all know is potentially extremely damaging and indeed was the feature of the events of 2007 and 2008.[138]

158. Implementing the G20 priorities alone will place a heavy legislative burden on the EU. The lion's share of action will need to be taken at a global level if it is to be effective. The economic welfare added by regional action therefore requires particularly careful scrutiny. We are concerned about the scale of the EU agenda, particularly given that the European Supervisory Authorities, which should at least be able to help the Commission prioritise its work, have only just been established. The focus of European effort should be on explicit commitments by the G20 for reform. These should be implemented in close cooperation and after careful consultation with other jurisdictions.

159. While many of our witnesses welcomed the principle of a consistent regulatory framework across Europe, they were also concerned that failure to get such regulation right would damage the financial services industry, and those who used it.[139] Our witnesses emphasised that although the damage would be felt first in the United Kingdom, it would potentially affect the entire European Union. Mr Rolet told us that if misplaced regulation led to the gradual relocation of financial services "it is unlikely to migrate to Frankfurt or Milan or Paris or Madrid. It is going to go to Asia."[140]

160. The first danger is political pressure may lead to bad regulation, or to regulatory uncertainty. Mr Andrew Baker, Chief Executive of the Alternative Investment Management Association, warned "there is a danger at the moment, and it's not confined to Europe, that there is too much political interference in the regulatory process and it's not helpful for market operators because they don't feel that they understand the rules."[141] Some of that pressure could come from European centres seeking to advance their own interests: Mr Rolet spoke about the "long-standing rivalry between the two financial centres, Paris and London" and the danger that some people might see "opportunity through the regulatory harmonisation process to claw back some business".[142] Some may come from a general political wish to take action, for example against short-selling, which may lead to regulations being made without an adequate evidence base.[143]

161. Witnesses stressed that effective regulation required deep knowledge of the market being regulated, and that there were many technical differences between markets.[144] They were confident that the FSA had the technical expertise required for effective regulation. Mr Abbott of the London Metal Exchange, where 90 per cent of the world's metal trading takes place, considered:

having a regulator that really understands the business is quite critical and is recognised by other global regulators as being critical. The problem that we have, therefore, with the concept of another layer or a different type of regulation coming from Europe is that it will necessarily come from countries that have no expertise in regulating our type of market.[145]

Commissioner Barnier considered that the United Kingdom should have confidence in its influence and its ability to convince on European regulation.[146] David Benson of Nomura told us that "the UK regulators, the Bank of England and the FSA, are taking a leadership role, which is definitely influencing events in Brussels and Europe more generally".[147] However, he noted "it's hard to know exactly whether they're taking sufficient account of British expertise".[148]

162. A further criticism was that particular European proposals had been produced without adequate consultation or impact assessments, and that processes could be rushed. While Commissioner Barnier stressed that European law required such assessments, and that he took consultation seriously, we were told that the Alternative Investment Fund Managers Directive (produced before Commissioner Barnier took up his post) had suffered from a lack of consultation at the outset, and as a result many technical issues still remained to be resolved.[149]

163. If the European Supervisory Authorities focus on improving coordination between regulators, and drawing up technical standards which are based on a deep understanding of the markets regulators have to deal with, they can add value. However we are concerned at the sheer scale and pace of the reforms taking place at European level. The Commission needs to ensure its reforms are technically sound, and only brought forward after consultation. It also needs to avoid the danger that political pressure may lead to poor regulation. Inappropriate regulation will not only damage the United Kingdom, but the European Union as a whole.

UK engagement with European regulators

164. We note that the FSA and the Bank of England have been playing a leading role in discussions on European regulation. That must continue. However, the new regulatory structure in the EU will be very different from the one being implemented in the UK. The ESAs will deal with both prudential regulation and conduct of business issues, and be focused on specific sectors. In the UK, prudential regulation across most sectors will be carried out by the PRA, with the CPMA focusing on conduct of business regulation.

165. In their written evidence the FSA warned there will be a risk that the UK regulatory voices will be weakened by this misalignment, especially with the ongoing restructuring in the next two years:

There is [...] a risk that the single UK regulatory voice in some cases is weakened by the fact that two or more organisations will share the representational role in the various international regulatory committees. In other cases (especially in Europe) the UK will only have one vote on each committee and will need to resolve conflicting objectives and interests between the various interested UK authorities. [...][150]

166. There will need to be a great deal of consultation between the UK regulators about the approach to be taken within the ESAs—to give one example, the CPMA will need to work with the Bank directly on issues surrounding market infrastructure, as the Bank will have responsibility over exchanges, clearings and settlements, all of which will be in ESMA's remit. The FSA believes that "[the problem] can be mitigated through clarity in the roles and objectives of, and effective coordination between the PRA and CPMA. Coordination will also need to extend to The Pensions Regulator and potentially other UK authorities."[151] In its response to the consultation, the Government has suggested that "different authorities will participate in sub-committees of the new ESAs—for example, with the CPMA sitting on the conduct committees of the banking and insurance supervisory authorities in Europe."[152]

167. The Government's decision to abandon the proposal to transfer the UKLA to the FRC, which we have already welcomed should improve coordination with Europe. The London Stock Exchange had been concerned about the previous proposals, telling us that:

Aligning the UK regulatory structure with the EU regulatory supervisors is vital to the UK maintaining a strong and credible voice in Europe. [...] The removal of the UKLA from the CPMA markets division means that the UK will only be directly represented at European level on secondary markets issues. Primary market regulation has historically been a source of competitive advantage to the UK and we would not want to see this eroded in the name of European harmonisation. [...]. [153]

168. In its summary of responses to the consultation document, the Government said:

The Government is committed to ensuring that there is continued, focused engagement by HM Treasury, the FSA and the Bank with European and international developments and that the UK's voice on negotiations is as strong and influential as ever. [...]

2.41 In order to provide continuity during the transitional period the UK's institutional representation in international forums will not change until the legislation to create this new structure is enacted. As the reform programme advances, the Bank and the FSA will work closely together to ensure that all relevant views are taken into account and adequately represented in international and EU negotiations.[154]

169. Witnesses were concerned that the United Kingdom should be properly represented in European institutions. Mr Andre Villeneuve of the City of London's International Regulatory Strategy Group told us:

I think we have to look very much at the detail I was talking about earlier, about how we're represented on the European bodies. What I didn't say, of course, is that I think we've done a poor job in making sure that we have the right people in the Commission and on these new bodies [...][155]

It is important that the UK, with a particularly large share of the financial services activity of the EU, secures appropriate representation on the EU regulatory bodies.

170. The establishment of the ESAs means the Government and the FSA need to treat engagement in European negotiations as a high priority. The United Kingdom's regulatory framework must be designed to ensure that engagement with Europe is effective.

HM TREASURY'S ROLE IN INTERNATIONAL NEGOTIATIONS

171. A further difficulty, which is not explicitly addressed in the consultation paper, is that while the supervisory authorities will take the lead in technical discussions at both European and international level, the Treasury and Finance Ministers will also play a leading role. The summary of responses to the Government's consultation notes:

The Government will consider how to ensure that effective coordination between authorities, in the European sphere as in all other matters, is supported in legislative and practical terms.[156]

Not only will there be problems of co-ordination; the Government will need to ensure that HM Treasury retains the technical capacity to play a leading role in such negotiations.

172. At national level the Government is proposing to devolve a great deal of power to independent regulators. We do not oppose this, but many of the actions to prevent a recurrence of the crisis depend on actions which must be negotiated at an international level. Both the regulators and the Government may be involved in such negotiations. There are two potential dangers. The first is that international regulation becomes the preserve of technocrats, and Governments may become dangerously disengaged. The second is that political pressure results in bad regulation. The Government should provide greater clarity about the way in which negotiations will be handled and co-ordinated, what role the Government will play, and how it proposes to minimise these risks.

133 HM Treasury, A new approach to financial regulation: summary of consultation responses, para 2.4 Back

134 http://www.bis.org/bcbs/basel3.htm Back

135 Sixteenth report of Session 2008-09, The Committee's Opinion on proposals for European financial supervision, HC 1088 Back

136 See http://www.fsa.gov.uk/Pages/About/What/International/european/esas/index.shtml Back

137 HC (Session 2010-11) 658, Q 75 Back

138 HC 658-i Q22 Back

139 See, for example, Qq 379-384, 470 Back

140 Q 380 Back

141 HC (Session 2010-11) 658, Q 42 Back

142 Qq 373-4 Back

143 HC 658-i, Q 42, see also Q 360, Q 364 Back

144 Qq 48-50, Q 360 Back