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Documents considered by the Committee on 16 January 2019 Contents

5European System of Financial Supervision

Committee’s assessment

Politically important

Committee’s decision

(a)—(c) Not cleared from scrutiny; further information requested; drawn to the attention of the Treasury Committee; (d) Cleared from scrutiny

Document details

(a) Proposal for a Regulation on the European Supervisory Authorities; (b) Proposal for a Directive amending Directive 2014/65/EU on markets in financial instruments (MiFID II) and Directive 2009/138/EC on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II); (c) Amendment of the proposal for a Regulation as regards the authorisation of CCPs; (d) Amended proposal for a Regulation amending Regulation 1093/2013 establishing the European Banking Authority and Directive 2015/849 on the prevention of the use of the financial system for the purposes of money-laundering or terrorist financing

Legal base

(a)—(d): Article 114 TFEU, ordinary legislative procedure; QMV

Department

Treasury

Document Numbers

(a) (39052), 12420/17 + ADD1–2, COM(2017) 536; (b) (39053), 12422/17, COM(2017) 537; (c) (39056), 12431/17, COM(2017) 539; (d) (40057), 12111/18, COM(2018) 646

Summary and Committee’s conclusions

5.1Following the financial crisis, the EU adopted numerous pieces of legislation to help prevent another destabilising run on European banks, such as the fourth Capital Requirements Directive and the Bank Resolution & Recovery Directive. It also passed three Regulations to establish the European Supervisory Authorities (ESAs) to help oversee financial sector: the European Banking Authority (EBA), the Securities & Markets Authority (ESMA) and the Insurance & Occupational Pensions Authority (EIOPA).

5.2Known collectively as the European System of Financial Supervision or ESFS,24 these Authorities have far fewer direct supervisory responsibilities than national regulators like the Bank of England, but assist the European Commission in drafting technical regulations and can—as a last resort—exercise powers to override national supervisors if it believes they are not properly applying EU legislation. Even though part of the ESA’s role is to monitor the performance of the EU’s national financial authorities, by law their governance structures are controlled by those same regulators.

5.3In September 2017, the European Commission proposed wide-ranging changes to the statutory framework that governs the work and powers of the ESAs, referred to as the ESFS review. Its proposals, which can be amended and must be approved by the European Parliament and a qualified majority of EU Member States to take effect, would alter the ESA’s governance structures to make them more assertive vis-à-vis the Member States’ domestic financial regulators; giving them a larger role in the supervision of non-EU firms providing financial services to EU-based customers; and expand the powers of ESMA to give it more supervisory responsibilities over European capital markets which are currently exercised at national level.

5.4In September 2018, the ESFS review was supplemented by a further proposal to give the European Banking Authority more powers to tackle money laundering following a series of banking scandals in different EU countries.25 This would give the EBA the ability to instruct national regulators to carry out investigations where it suspects anti-money laundering laws have been breached, and establish a centralised data hub for weaknesses in specific banks’ AML practices.

5.5The European Scrutiny Committee previously set out the detail of the proposed reforms, including the Government’s negotiating position and the potential implications for the UK in the context of its withdrawal from the EU, in its Reports of 13 December 2017 and 28 February 2018, and published a further report on the new amendments relating to money laundering on 24 October 2018.

5.6In our Reports, we noted in particular that many of the Commission’s proposals were driven by the UK’s decision to withdraw from the EU. This had led to concerns that British financial services providers could seek to preserve their current market share after Brexit without being subject to EU law, by establishing ‘letter box’ entities in those Member States with the perceived ‘easiest’ regulatory approach. To counteract this perceived risk, the Commission had drafted the ESA reforms to give the ESAs more centralised oversight of financial markets and close any potential ‘loopholes’ for access by non-EU firms created by divergent national application of EU legislation.

5.7The ESFS review could therefore create new restrictions on how the British financial services industry accesses European markets after EU exit. Moreover, the legislation affect both the industry and its regulators in the UK—the Bank of England and the Financial Conduct Authority—during the proposed post-Brexit transitional period, when EU law would continue to apply as if the UK were still a Member State (but, crucially, without representation or voting rights for UK Government or regulators in EU institutions and bodies like the ESAs). Given the contentious proposals to strip domestic supervisors of certain regulatory responsibilities and transfer them to the ESAS, it seemed likely negotiations would be protracted.

5.8On 9 January 2019, the Economic Secretary to the Treasury (John Glen MP) provided a detailed update on the state of play in the negotiations on the reforms between the EU’s Member States in the Council of Ministers.

5.9He explained that Member States had fast-tracked their discussions on the September 2018 AML proposals, given the perceived urgency in addressing gaps in enforcement of the EU’s existing Anti-Money Laundering Directive. EU Finance Ministers are therefore expected to adopt the Council’s common position on those elements of the proposal when they meet in Brussels on 22 January 2019. Explaining that Member States have agreed number of changes to legal text in line with the UK’s objectives, the Minister asked for scrutiny clearance to enable the Government support the compromise text.26 The changes sought still need to be agreed with the European Parliament, which adopted its position on 10 January 2019.

5.10Negotiations between the Member States on the remaining aspects of the ESFS review—including the governance of the ESAs, their supervision of non-EU firms and the powers of ESMA—are on-going. The Minister noted that national Governments are seeking to significantly water down the Commission’s proposals, by preserving the dominant role of the national regulators in the running of the ESAs and limiting their role in the oversight of non-EU–British firms active within the Single Market. After the Member States agree on their ‘general approach’, they will need to negotiate with the European Parliament on the final shape of ESA reforms. The Minister has highlighted in particular that Parliament wants to extend EU-level oversight of the settlement infrastructure for derivatives transactions, which the Treasury strongly opposes. (It also remains unclear whether the Parliament is willing to discuss the AML provisions referred to above separately from the overall package of reforms, in which case their entry into force could be delayed.)

Our conclusions

5.11We thank the Minister for the information on the negotiations for the reform of the EU’s financial Supervisory Authorities provided in his letter of 9 January 2019.

5.12As we have noted in previous Reports on the reform of the European System of Financial Supervision, we remain concerned about the implications of this legislative process for the UK despite its scheduled withdrawal from the European Union in March this year. During the proposed post-Brexit transitional period, which could last until 31 December 2022 under the draft Withdrawal Agreement, EU financial services law would remain applicable in the UK as if it were still a Member State. However, from 30 March the Treasury would no longer have a right to participate in the legislative deliberations in Brussels; the Government would no longer have a vote in the Council of Ministers; and the Bank of England and Financial Conduct Authority would be shut out from the governance bodies of the ESAs.

5.13Any new powers the ESAs gain while the transition is in force would extend to the UK. The reforms as originally proposed would be particularly problematic for the UK if they took effect during the transitional period, because they could give the Authorities more powers over national regulators and individual firms while the UK—uniquely among all countries in the Single Market27—would not be represented on their Boards of Supervisors or have a say over the independent membership of the proposed Executive Boards. In particular, the European authorities could potentially instruct UK regulators to carry out investigations into specific firms, or take over some of the supervisory responsibilities for certain financial products and market infrastructure.

5.14Our recent observations about the relevance of other on-going EU negotiations on financial services legislation to the future UK-EU trade arrangement also apply to the ESFS review. Whether or not the Withdrawal Agreement is ratified and the transitional period takes effect, the Government has accepted that any preferential access for UK firms to the EU’s market for financial services will be based on EU law. In particular, the focus will be on the ‘equivalence’ mechanism that allows the European Commission to declare the UK’s regulatory approach in a specific financial sector as equivalent to the EU’s, in some cases providing enhanced market access rights. The ESFS review could result in a greater role for the ESAs in preparing and monitoring equivalence decisions (although they would have no formal power to rescind or modify such arrangements).28 It also foresees more ESA oversight of the application of EU law related to delegation and outsourcing—both ways for non-EU firms to carry out financial services for EU-based customers. This draft legislation could therefore have a significant impact on the UK’s access to the Single Market for financial services after Brexit.

5.15We reiterate in this respect that, without the interim period provided by the transition under the Withdrawal Agreement, market access rights for British financial services firms will be severely disrupted on 30 March 2019. In the context of the broader political acrimony of a ‘no deal’ scenario, it is unlikely the European Commission would begin equivalence assessments until the ‘separation issues’ contained in the Agreement—notably as regards Ireland, citizens’ rights and the settlement of the UK’s financial commitments vis-à-vis the EU—were resolved.

5.16It is noteworthy in this respect that the recent Financial Services (Implementation of Legislation) Bill would give the Treasury the power to implement a number of pending EU financial services proposals, including the ESFS review, into UK law by means of Statutory Instrument in the event that the Withdrawal Agreement is not ratified (and EU law ceases to apply in the UK in March 2019).29 The need for domestic implementation of the ESA reforms in a ‘no deal’ scenario seems counterintuitive, given that the proposals relate to the powers of EU bodies that, by definition, would have no jurisdiction over the UK in such an eventuality. We understand the Government included the proposal in the scope of the Bill to make it easier to implement changes to allow financial markets to continue functioning as smoothly as possible, for example to allow the Financial Conduct Authority to share information with the ESAs in return for EU investment firms ‘delegating’ their activities to UK-based entities after Brexit.

5.17As requested by the Minister, we are content to now grant the Government a scrutiny waiver in relation to the anti-money laundering elements of the proposal, given the relatively straightforward nature of those proposals. However, we retain the overarching proposal to amend the ESA Regulations under scrutiny pending further information on developments in the legislative process.

5.18As regards the powers being sought by the Government to implement ‘in flight’ EU proposals—including the ESFS review—by Statutory Instrument, we note that the Financial Services Bill would give the Treasury the power to implement EU legislation which is likely to still be in draft form when the Bill receives Royal Assent. We would urge Parliament to carefully consider the scope of the powers given to the Government to implement new EU financial services legislation by regulations after EU exit, when it is no longer under a legal obligation to do so, and whether primary legislation would be more appropriate.

5.19We draw these developments to the attention of the Treasury Committee, given their interest in the implications of Brexit for the UK financial services industry and the potential substance of any future UK-EU arrangement in that area.

Full details of the documents:

(a) Proposal for a Regulation on the European Supervisory Authorities: (39052), 12420/17 + ADD1–2, COM(2017) 536; (b) Proposal for a Directive amending Directive 2014/65/EU on markets in financial instruments (MiFID II) and Directive 2009/138/EC on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II): (39053), 12422/17, COM(2017) 537; (c) Amendment of the proposal for a Regulation as regards the authorisation of CCPs: (39056), 12431/17, COM(2017) 539; (d) Amended proposal for a Regulation amending Regulation 1093/2013 establishing the European Banking Authority and Directive 2015/849 on the prevention of the use of the financial system for the purposes of money-laundering or terrorist financing: (40057), 12111/18, COM(2018) 646.

Background

5.20After the financial crisis, the EU Member States made major changes to the supervision of their financial markets. Notably, they created the European System of Financial Supervision (ESFS), which is built on a two-pillar system of macro-prudential and micro-prudential supervision. Collectively, these efforts were aimed at preventing another shock to the financial system. To underpin this work, many new regulatory initiatives were introduced at EU-level in recent years, including the Capital Requirements Regulation for banks, Solvency II for insurers and the second Markets in Financial Instruments Directive (MiFID II) for investment firms.

5.21At Member State level, the relevant domestic financial authorities, like the Bank of England and the Prudential Regulation Authority in the UK, implement the ESFS. These are referred to as ‘national competent authorities’ or NCAs in the legislation. In most cases, national regulators retain direct supervisory oversight of financial institutions in their jurisdiction, even where their powers and responsibilities are set out in EU law. At EU-level, the macro-economic oversight is provided by the European Systemic Risk Board (ESRB), which issues advice and reports on overall risks to financial stability in the European Union.

5.22Meanwhile, the major innovation of the ESFS was the creation of three “European Supervisory Authorities” (or ESAs), which became operational in 2011. They have sector- and firm-specific responsibilities covering the banking, insurance and securities markets respectively. The role of the ESAs—the European Banking Authority (EBA),30 the European Insurance & Occupational Pensions Authority (EIOPA) and the European Securities & Markets Authority (ESMA)—is to oversee the uniform implementation of the EU’s post-crisis regulation of the financial services industry. They have four broad sets of powers under EU law:

5.23The decision-making powers of each ESA—for example to issue draft technical standards or declare a national regulator in breach of EU law—rest with its respective Board of Supervisors (BoS), on which only the Member States’ national competent authorities have a vote (with qualified majority voting rules for the most important decisions).35 Although day-to-day management of the ESAs is handled by Management Boards, they are also dominated by a sub-set of national supervisors,36 and they have few direct responsibilities. In practice therefore, the UK’s regulators—in particular the Prudential Regulation Authority and Financial Conduct Authority—have had a significant influence over the work of the ESAs, in particular by being closely involved in the drafting and approving of technical standards in a range of financial sectors that subsequently become European law.

Review of the European System of Financial Supervision

5.24The European Commission carried out a comprehensive evaluation of the ESFS from 2014, which highlighted concerns about the governance and effectiveness of the ESAs in using their existing powers to foster regulatory convergence, given their functioning is effectively controlled by the national regulators whom they are meant to monitor and, if necessary, censure. It also concluded that other political developments—including the UK’s decision to withdraw from the EU, the increased cross-border flows of capital as part of the Capital Markets Union, and the further integration of the European banking sector—necessitated a rethink of the Supervisory Authorities’ remit and powers.

5.25In the light of these developments, the Commission in September 2017 tabled a package of proposals to amend the 2010 Regulations that established the Supervisory Authorities.37 As we described in some detail in our previous Reports of 13 December 2017 and 28 February 2018, these reforms would expand the powers of the ESAs, in particular for the European Securities & Markets Authority (ESMA); alter their governance structures to make the ESAs more assertive vis-à-vis the Member States’ NCAs; and impose a new industry levy to fund their work and make them independent of the EU budget.38 In September 2018, the Commission added a further proposal to expand the powers of the European Banking Authority to tackle money laundering following the various banking scandals involving EU financial institutions.

5.26We have described the individual elements of the proposals in more detail in paragraphs 31 to 56 below, in light of the most recent information received from the Treasury about the Member States’ negotiations on the reforms.

Previous Parliamentary scrutiny of the proposals

5.27The European Scrutiny Committee considered the proposals at the early stages of the legislative process in December 2017 and February 2018, on the basis of an Explanatory Memorandum submitted by the Treasury in October 2017. We concluded that the proposed legislation was of major political importance: it would substantially alter the European System of Financial Supervision as it was created seven years ago, and expand the powers of the Supervisory Authorities.

5.28In particular, it was abundantly clear from the explanatory notes accompanying the European Commission’s original proposals that its ESA reform efforts were driven, at least in part, by the UK’s withdrawal from the EU. The Commission expressed concerns that UK financial services firms might try to establish ‘letter-box’ entities in the EU, servicing European clients from the UK without substantially moving their operations to an organisation within the Single Market as required by EU law. This, the Commission argued, increased the need for stronger ESAs so they could ensure that all Member State regulators apply the EU’s regulatory requirements for “third country” firms in the same way.

5.29Moreover, during the proposed post-Brexit transitional period, the ESAs would retain their powers in relation to the UK financial services industry and regulators (even though the Bank of England and Financial Conduct Authority would lose their voting rights and representation within the Boards of Supervisors, the only national regulators within the Single Market to be deprived of representation in this way).39 Even after transition, the Government wants to sustain the substantial export of financial services to the EU, which will inevitably require cooperation with the ESAs—in particular if they take on an increased role in the process of determining whether the UK is ‘equivalent’ with the EU as the basis for preferential market access rights.

5.30As such, the impact of the proposals on the UK financial services industry could be significant for many years after the UK ceases to be an EU Member State. We were disappointed therefore that the Treasury’s Memorandum did not reflect on the implications of the proposals for the UK financial services industry in the context of Brexit, or offer any substantive assessment of the proposed reforms in general.

Developments since February 2018

5.31On 9 January 2019, the Economic Secretary to the Treasury (John Glen MP) wrote to the Committee with an update on the state of play in the negotiations on the ESFS review, including the more recent proposal relating to money laundering.

Governance of the ESAs

5.32With respect to the governance of the ESAs—that is to say, who controls their decision-making processes—the Commission proposed to reduce the dominance of the domestic regulators on the management structures of the Supervisory Authorities. It noted, for example, that none of the three ESAs have ever declared a breach of EU law by a national supervisory authority (since those authorities themselves have a vote on whether to declare such a breach).40

5.33The Commission therefore argued that the effectiveness of the ESA’s independent monitoring of individual Member States should be improved. This would ensure it could effectively monitor whether domestic regulators apply EU law uniformly, and take action if not. One of the main aims would be to ensure that non-EU financial services firms—especially British ones—would not be able to find a Member State with a ‘light touch’ regime allowing them to establish ‘letterbox entities’ within the EU while carrying out their actual operations back in their home country.41

5.34To achieve this, the Commission proposed to replace the ESA’s Management Boards—which have few powers, and are controlled by a sub-set of domestic regulators—with new Executive Boards with more powers. These Boards would have full-time independent members,42 and take over some key decisions from the ESA’s Board of Supervisors, such as determining whether a national regulator had failed to correctly apply EU financial services legislation.43 In addition, this new body would set EU-wide priorities for supervision in the form of a “Strategic Supervisory Plan” (SSP), against which all competent authorities would be assessed.44 It would also conduct independent reviews of the national implementation of EU law with less direct involvement of the staff of the domestic regulators themselves.45

5.35In his letter of 9 January 2019, the Minister explained that “Member States remain divided” about reforms of the ESA’s governance structures. In late 2018, a new proposal was put forward by Austria which would reject most of the Commission’s suggestions in this area and instead change the composition of the Management Board to five members elected from the Board of Supervisors (BoS), but with the addition of “two full-time external and independent members with clearly defined policy and managerial tasks”. (The other option under consideration within the Council is to simply retain the status quo and make no changes to the Authorities’ governance at all). The Minister notes that the UK—given its scheduled withdrawal from the EU—has “remained relatively quiet on this debate” but voiced its support “for retaining the status quo”. Under either option, it does not appear there be a significant dilution of the control exercised by the NCAs over the work of the ESA’s.

New powers for the ESAs

5.36The second element of the Commission’s ESA reform proposals concerned the specific powers exercised by the Authorities. In particular, it suggested that the ESAs should play a larger role in supervising access of non-EU firms active on the EU market (whether under a so-called forma ‘equivalence’ regimes, or by means of outsourcing and delegation of tasks by EU companies to ‘third country’ entities), and give new direct supervisory responsibilities to ESMA in relation to investment prospectuses, market data, financial benchmarks and certain types of investment funds.

Equivalence, outsourcing and delegation

5.37As noted, the Commission proposals contain several suggested changes to the way in non-EU financial services firms operating within the EU are supervised. This was driven, to a large extent, by Brexit amid concerns that the British financial industry could try to maintain current levels of activity within the EU without being subject to European law (for example through ‘letter box’ entities).

5.38First, the proposals reinforce the role of the Supervisory Authorities in the equivalence process. Under certain pieces of EU financial legislation, the European Commission can make a legal determination that a non-EU country’s regulatory regime for specific financial products or services is equivalent to the EU’s. Such an ‘equivalence decision’ confers certain benefits on companies based in the country in question, which can range from prudential and regulatory reliefs for EU firms that deal with them to full ‘passporting’ rights allowing non-EU firms to operate throughout the Single Market. The precise advantages of equivalence therefore vary sector-by-sector.

5.39As part of the ESFS review, the Commission had proposed to formalise the role of the ESAs in providing advice when preparing equivalence decisions, and to entrust them with the responsibility for monitoring on an on-going basis the regulatory and supervisory developments in third countries for which equivalence decisions are already in place. They would submit a confidential report on their findings to the Commission on an annual basis, which would use this information to decide whether to maintain, modify or withdraw equivalence. The ESAs would also have to agree administrative arrangements with the third country supervisor allowing for exchange of information, and permitting the ESA to perform on-site inspections in their territory.

5.40Secondly, again in response to the UK’s withdrawal from the EU, each Supervisory Authority would gain new powers to obtain data from national regulators about their supervision of ‘third country’ firms. This would include information on each EU country’s authorisation or registration of financial firms whose business plan “entails the outsourcing or delegation of a material part of its activities […] into third countries”, meaning they would “benefit from the EU passport while essentially performing substantial activities or functions outside the Union”. Information gathered in this way would then enable the ESAs to assess whether the Member States are effectively supervising outsourcing, delegation and risk transfer arrangements in third countries.

5.41The Minister’s update of 9 January 2019 notes that, with respect to supervision of non-EU countries within the Single Market, the Member States’ negotiations focused on the ESAs role in the on-going monitoring of ‘equivalence’ once granted by the European Commission. They have accepted a larger role for the Supervisory Authorities in monitoring continued compliance with the conditions for equivalence by ‘third countries’, focussed on “implications for financial stability; market integrity; investor protection; the functioning of the internal market; relevant regulatory and supervisory developments and practices; and market developments relevant to a risk-based equivalence assessment”.46

5.42As regards the ESA’s monitoring of outsourced and delegated activities by EU-based firms to non-EU (e.g. UK) entities, the Minister notes that the Member States want to delete the power for the EBA, ESMA and EIOPA to “approve or challenge” individual firms plans for outsourcing, delegation and risk transfer arrangements to third countries. Instead, the Austrian Presidency of the Council suggested the creation of ‘coordination groups’ to promote supervisory convergence in these areas.

5.43Given the importance of the EU’s approach to the treatment of non-EU firms on its market for financial services for the UK—not least by means of ‘equivalence’ decisions, this is a key area of the negotiations for the Treasury. In his letter, the Economic Secretary says the UK “will continue to push for greater transparency in this process”, specifically by asking for the ESAs annual report on equivalence “to be shared with the Council and European Parliament”.

New supervisory powers for ESMA

5.44As part of the ESFS review, the European Commission also proposed a substantial expansion in the direct supervisory responsibilities of the European Securities & Markets Authority (ESMA). This is the Paris-based EU Supervisory Authority that oversees EU legislation that affects capital markets, notably the second Markets in Financial Instruments Directive; the Benchmarks Regulation; the Prospectus Regulation; and the European Market Infrastructure Regulation (EMIR).

5.45A common thread that runs through these laws is that they typically create a framework for market participants to operate across the Single Market in the relevant sector (the so-called ‘passport’), but have kept supervisory responsibility for market participants at Member State level. A key principle in this context is that the regulator of the home Member State of the firm typically has primary supervisory responsibility, even in respect of activities carried out elsewhere in the EU.47 When making its ESA reform proposals, the Commission expressed concerns that this system has allowed for divergence in the way EU capital markets laws are being applied by different Member States, with gaps appearing especially in the enforcement of investor and consumer protection rules for activities carried out in another EU country than the home Member State.48 This creates the risk of firms seeking to establish themselves in the EU country with the perceived least-intrusive supervisory approach, from where activities can be undertaken throughout the EU with limited powers for other NCAs to intervene.

5.46In light of these developments, the Commission proposed to increase the direct supervisory responsibilities of ESMA to ensure greater consistency in the application of EU law irrespective of the Member State in which a financial services firm is based.49 In particular, it wanted to make the Authority responsible for authorisation and supervision of:

5.47The Minister’s latest update on the negotiations explained that most of these proposals have been rejected or watered down by the Member States. They are seeking to remove the amendments relating to prospectuses altogether, while limiting ESMA’s direct supervisory responsibilities in relation to critical benchmarks (leaving domestic discretion on recognition of non-EU benchmarks intact) and data reporting service providers.

5.48However, the European Parliament is pursuing an amendment to the ESA proposals to give ESMA “direct supervision of third country Central Security Depositaries and Trading Venues” under the EU’s CSD Regulation.55 This governs the market infrastructure that allows for the settlement of securities transactions in the EU; many of the firms that provide such services are British, meaning the UK post-Brexit would be disproportionately affected by a change in how their access to the European market is regulated. The Minister has informed us that it is a “priority” for the Treasury to “water […] down” the Parliament’s proposals in this area.

Anti-money laundering powers of the EBA

5.49In response to several scandals—including notably the revelations that Danish lender Danske Bank potentially laundered as much as €200 billion of criminal proceeds through its Estonian branch between 2007 and 2015—the European Commission in September 2018 decided further action was necessary to coordinate the combat against money-laundering in the EU.

5.50To achieve this, the Commission proposed a further amendment to the Regulation establishing the European Banking Authority in the context of the ESFS review. Its supplementary proposal would give the EBA an explicit statutory mandate to work with national banking regulators properly apply the EU’s anti-money laundering rules as part of their supervisory work. In particular, the Authority would:

5.51In a parallel development, the European Parliament has also pushed for amendments to the Capital Requirements Directive to address legal restrictions on confidentiality that prevent prudential regulators from cooperating and exchanging information with anti-money laundering authorities, including those in other EU Member States.57 (The logic behind this is that financial regulators have more powers than law enforcement agencies to intervene in the operation of banks and investment firms, including—as a last resort—suspending or withdrawing their operating licence, and that they should therefore be able to cooperate in anti-money laundering investigations.)58 These discussions are taking place in the context of a different set of proposals on risk reduction measures for the banking sector, which we considered in our Report of 9 January 2019.

5.52The Minister’s letter in January 2019 provided a detailed update on the state of play in the negotiations on the role of the EBA in relation to anti-money laundering, as this aspect of the ESA reform proposals has been fast-tracked given the spate of recent money laundering scandals. The Economic Secretary reiterates that the Government “is in favour of a more coordinated [EU] approach to anti money laundering” and is “supportive of the EBA playing a leading role in achieving this”.

5.53Following negotiations among Member States in the Council, a number of changes have been proposed in the following areas:

5.54Given the perceived urgency in addressing gaps in the EU’s enforcement of its anti-money laundering rules, this element of the ESFS proposals has been prioritised in discussions among Member States. The Minister has now informed us that EU Finance Ministers are likely to formally adopt a ‘general approach’ on the AML powers of the EBA—reflecting the proposed changes described above—at their meeting on 22 January 2019. This would constitute the basis for negotiations with the European Parliament on the final text of the legislation in the near future. As such, the Minister has requested the Committee clear the AML proposal from scrutiny to “enable us to support the agreement that meets the UK’s objectives” at the Council meeting.

Funding mechanism for the ESAs

5.55The final element of the original Commission proposals for reform of the ESAs concerned the way in which they are funded. At present, the Authorities get obligatory contributions from the Member States’ national competent authorities, a subsidy from the EU budget, and—in the case of ESMA—fees paid by market participants subject to direct supervision.65 The Commission had suggested the Supervisory Authorities should instead charge a levy on firms within their remit to cover 60 per cent of the relevant ESA’s running costs, with the remainder being drawn from the EU budget.66 The direct contribution by NCAs would be eliminated entirely.

5.56The Treasury noted in its initial Explanatory Memorandum that “the proposals for increased industry funding will […] be contentious, and […] unlikely to be supported by the financial services sector”. In his letter of 9 January 2019, the Economic Secretary confirmed that the most recent compromise legal text circulated to Member States “deletes all references to financial contributions from industry”, which the UK and many other Member States support.

Next steps in the legislative process

5.57As described in paragraph 54 above, EU Finance Ministers are expected to agree on their joint position on the specific proposal on the EBA’s anti-money laundering powers at their meeting on 22 January 2019. That would open the way for negotiations on the final text of that element of the draft legislation with the European Parliament.

5.58The Parliament’s Economic & Monetary Affairs Committee adopted its position on the ESFS reform proposals—including the anti-money laundering powers of the EBA—on 10 January 2019, but the resulting Report has not yet been published. The Minister’s letter noted that the Government expected MEPs to keep the AML elements linked to the remainder of the ESFS proposals, rather than fast-tracking separately like the Council has done. The Treasury is “working with other Member States” to begin negotiations on the AML part of the text as soon as possible to ensure they can enter into force before the rest of the package is agreed. With respect to the non-AML elements, the Government is seeking to “delay the main [ESFS] proposal from being agreed” before the European Parliament is dissolved in April ahead of the European elections, delaying its eventual entry into force.67

5.59As we have noted, the ESFS reform proposals remain important for the UK in the context of its withdrawal from the EU (both during the proposed post-Brexit transitional period, when amendment to European financial services law would apply in the UK, and during negotiations on a future UK-EU trade agreement). Therefore, the proposals remain under scrutiny while the legislative process continues. We have set out our assessment of the potential implications of the reforms described in this Report in our conclusions in paragraphs 11 to 19 above.

Previous Committee Reports

See (39052), 12420/17 + ADD 1–2, COM(17) 536: Fifth Report HC 301–v (2017–19), chapter 9 (13 December 2017) and Fourteenth Report HC 301–xiv (2017–19), chapter 7 (21 February 2018).

24 The ESFS also compromises the European Systemic Risk Board (ESRB), which is not a regulatory body but monitors the build-up of macro-prudential risks in the financial system (e.g. housing bubbles).

25 In parallel, the Commission also proposed changes to the functioning of the European Systemic Risk Board. We cleared this proposal from scrutiny on 21 February 2018.

26 See paragraphs 49 to 54 of this chapter for more information on the changes sought by the Member States in relation to the anti-money laundering proposals.

27 Norway, Iceland and Liechtenstein have implemented the original EFSF Regulations as part of the EEA Agreement, but the direct and indirect supervisory functions of the ESAs are performed by the EFTA Surveillance Authority for those countries. The EFTA Surveillance Authority and the domestic regulators of the EFTA-EEA countries also have the right to participate in ESA meetings as observers.

28 There are also various other pending proposals which are likely to affect the parameters for equivalence assessments of the UK following Brexit, including the investment firm review and proposals to amend the Market Infrastructure Regulation.

29 See the Financial Services (Implementation of Legislation) Bill.

30 The EBA has been based in London since its establishment, but will move to Paris from 29 March 2019 due to the UK’s withdrawal from the EU.

31 Regulatory Technical Standards proposed by the ESAs take the form of Delegated Acts, which can be vetoed by either the European Parliament or the Member States in the Council by qualified majority. Implementing Technical Standards take the form of Implementing Acts which must be approved by a qualified majority of Member States.

32 European Commission Impact Assessment SWD(17) 308, p. 24.

33 See Regulation (EU) No 462/2013 on credit rating agencies.

34 See Regulation (EU) No 648/2012 on the European Markets Infrastructure (EMIR).

35 The UK is currently represented by the Prudential Regulation Authority (PRA) of the Bank of England (EBA), the PRA and the Pensions Regulator (EIOPA) and the Financial Conduct Authority (ESMA). Votes on the Board of Supervisors are weighted for the most important decisions (e.g. the adoption of draft technical standards). The EFTA-EEA countries Norway, Iceland and Liechtenstein are entitled to attend Board meetings as observers.

36 Members of the Management Boards are elected by and from the domestic regulators represented on the Board of Supervisors. The UK is not currently represented on any of the three Management Boards.

37 In parallel, the Commission also proposed changes to the functioning of the European Systemic Risk Board. We cleared this proposal from scrutiny on 21 February 2018.

38 The ESFS review as tabled by the Commission consisted of the core proposal amending the ESA Regulations, as well as two supplementary proposals amending EU legislation on investment services & insurance and securities to ensure consistency. In addition, in September 2018 the Commission added a further supplementary proposal related to the EBA’s anti-money laundering powers (see paragraphs 49 to 54 of this chapter).

39 Norway, Iceland and Liechtenstein have implemented the original EFSF Regulations as part of the EEA Agreement, but the direct and indirect supervisory functions of the ESAs are performed by the EFTA Surveillance Authority for those countries. The EFTA Surveillance Authority and the domestic regulators of the EFTA-EEA countries also have the right to participate in ESA meetings as observers.

40 The Commission also argued that the restriction of voting rights on the Boards to national authorities only “implies that an inherent EU perspective is both numerically underrepresented and carries no weight in terms of votes”.

41 See Commission Impact Assessment SWD(17) 308, p. 96. All three ESAs have also warned of the risk of UK companies establishing “letter box” companies within the EU after Brexit. See the warnings from the EBA, EIOPA and ESMA.

42 The members of the Executive Boards would be appointed by the Council after approval of a shortlist by the European Parliament.

43 For Central Counterparties (CCPs), organisations that act to absorb the risk of a party defaulting in a derivatives trade, the Commission put forward a supplementary proposal that indirect supervisory powers—like a ‘breach of Union law’ procedure—would lie with the ‘Executive Session’, a CCP-specific body within ESMA (rather than with the Board of Supervisors or the Executive Board).

44 The Minister’s latest letter does not indicate whether the Member States have supported or rejected the proposals in relation to Strategic Supervisory Plans, although the UK had already said it was opposed to the idea.

45 Under the Commission proposal, in situations where ESMA exercises direct supervisory powers (for example in relation to the authorisation of credit rating agencies or trade repositories), its Board of Supervisors would only be able to reject draft decisions by the Executive Board by a ‘super-majority’.

46 However, under amendments being considered by the Council, the ESAs would only produce one overarching annual report to cover their monitoring of all equivalence decisions within their remit, rather than on a country-by-country basis. Moreover, the requirement for national authorities to share their draft administrative arrangements with non-EU supervisory authorities would be removed; instead the ESAs would develop model administrative arrangements that national regulators “will be encouraged, but not required, to follow”.

47 The exceptions are EU-based credit rating agencies and trade repositories for derivatives contracts, which are supervised directly by ESMA for all activities within the EU.

48 In particular, the Commission said that “there are concerns that home [competent authorities] might be less strict in enforcing rules, in particular on consumer and investor protection, in relation to activities carried out in Member States other than the home Member State. This might be due to constraints in (financial) resources or (language) skills or due to a lack of incentive or simply due to consumers or investors having problems to identify and to address the competent authority in another Member State.”

49 The Five Presidents’ Report on Completing Europe’s Economic and Monetary Union of June 2015 set the objective of, ultmately, a single capital-markets supervisor for the entire EU.

50 The Commission argued that data reporting services are “an inherently Union-wide business”, and that regulatory and supervisory problems in this sector “cannot be addressed by Member State action alone”. In addition, it wanted to consolidate the collection of trading data within ESMA, replacing the current system where each NCA must gather data from multiple operators throughout the EU, which is then transmitted to ESMA for compilation and analysis, and then sent back to the competent authorities to be used as part of their supervisory responsibilities.

51 Benchmarks used in financial contracts by EU financial institutions, like LIBOR and EURIBOR, can be compiled and administered from a non-EU country. However, under the 2016 Benchmarks Regulation, this requires the regulatory system of the home country of the benchmark to have been deemed ‘equivalent’ by the European Commission, or for it to get formal ‘recognition‘ by the financial regulator of an EU Member State under certain conditions.

52 To raise capital through public offers or have securities admitted to be traded on regulated markets, companies need to provide potential investors with a prospectus which describes the company’s business, structure and finances. In the EU, the contents and issuance of such documents are regulated by the new Prospectus Regulation, which will replace the existing Prospectus Directive from July 2019. Prospectuses are approved by national authorities, and are valid throughout the EU.

53 Under the Prospectus Regulation, non-EU firms can issue prospectuses if they either submit it for approval by a Member State or if their domestic regulatory regime has been deemed ‘equivalent’ to the EU’s by the European Commission.

54 Funds with EuVECA or EuSEF designation which hold more than €500 billion (£440 billion) in assets under management must be managed by a fund manager authorised and supervised by their national competent authority under the Alternative Investment Fund Managers Directive (AIFMD). For these funds, the Commission proposes that ESMA should be responsible for ensuring both compliance with the EuVECA and EuSEF Regulations, and with the relevant national law implementing the AIFMD.

55 The original Commission proposal does not foresee extending ESMA’s powers under the CSD Regulation. The Parliament’s reasoning for its proposed change is set out in amendment 325 of document PE627.677.

56 If it is not satisfied with the regulator’s response, the EBA’s ability to instigate a ‘breach of Union law’ procedure would be extended to anti-money laundering legislation. This could theoretically result in the EBA ordering either the national regulator or a specific financial market operator to “take all necessary action” to comply with their legal obligations. However, the initiation of a “breach of Union law” procedure against a national regulator would ultimately have to be made by the EBA’s Board of Supervisors. Under the current legal framework, it is only the EU’s national regulators themselves who are voting members of the Board. Under the Commission’s wider ESFS reform proposals, such decisions would be taken by a new four-person Executive Board composed of full-time independent members.

57 The relevant amendments are contained in European Parliament Report A8 2018/243, in relation to a new article 4a of Article 117 (“Competent authorities [and] financial intelligence units […] supervising obliged entities listed in [the AMLD], shall cooperate closely with each other within their respective competences and shall provide one another with information relevant for this under […]”) and a change to Article 56 on exchange of information (“[The Capital Requirements Directive] shall not preclude the exchange of information between competent authorities within a Member State, between competent authorities in different Member States or between competent authorities and the [competent authorities referred to in Article 48 of the Directive (EU) 2015/849], in the discharge of their supervisory functions”.

58 In May 2018, the Member States and the European Parliament amended the EU’s Anti-Money Laundering Directive to improve the exchange of information between anti-money laundering and prudential authorities. However, there is no “mandatory mechanism or detailed guidance” on structural cooperation between the two—especially between different Member States.

59 The Minister’s letter notes that the Council Legal Services used “previous examples” to demonstrate that the draft text as amended by the Austrian Presidency—which inserted a clarification that the EBA could only order investigations for breaches of national laws “to the extent that they transpose [EU] Directives” is “workable and legally sound”.

60 The UK had sought a further extension to 25 days, but the Minister says that the Treasury “appreciate[s] that 15 is a good compromise”.

61 The Minister notes in his letter that recent cases of money laundering, as well as terrorist financing, took place through sectors within ESMA, like trading venues.

62 Chief Executives of national financial regulators would still be involved in the work of the AML Committee through their representation on the ESA’s Boards of Supervisors.

63 The revised legal text would define a weakness as a “breach, potential breach or ineffective/inappropriate application of legal provisions”. The Member States want to lay down further details of the EBA’s collection of information by means of a Delegated Act at a later stage.

64 The Council is also seeking an amendment that would require the EBA to inform the national regulator which originally provided the requested information about the request. The original Commission proposal allowed national regulators to access information on AML weaknesses held by the EBA on simply on “a need-to-know and confidential basis”.

65 The ESAs get 60 per cent of their budget from NCA contributions and 40 per cent from the EU budget. National contributions are proportionate to each country’s share of votes under the Council qualified majority rule as it applied until October 2014. As a result, the UK contributes approximately 8 per cent of the NCA contributions each year (amounting to €4.4 million in 2016).

66 The industry levy would be set on an annual basis, based on the estimated workload for each Authority for each category of market participants.

67 The Minister also informed the Committee in his letter of 9 January 2019 that the Treasury had “belatedly” identified ‘Justice and Home Affairs’ content in the ESFS proposal, relating to exchange of information between financial regulators and law enforcement authorities. The Government maintains triggers the UK’s opt-in protocol for such measures even where the draft EU legislation has an ‘internal market’ legal base, and the Minister says the UK has therefore purported to opt-out of this particular element of the proposals. The Committee’s long-standing position is that the JHA protocol is not engaged unless draft EU legislation as a legal base in Title V of the Treaty.



Published: 22 January 2019