3European System of Financial Supervision
Background and Committee’s conclusions
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Committee’s assessment |
Politically important |
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Not cleared from scrutiny; further information requested; but scrutiny waiver granted for the ECOFIN Council of 12 February 2019 |
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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 |
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Legal base |
(a)—(c): Article 114 TFEU, ordinary legislative procedure; QMV |
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Department |
Treasury |
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Document Numbers |
(a) (39052), 12420/17 + ADD1–2, COM(17) 536; (b) (39053), 12422/17, COM(17) 537; (c) (39056), 12431/17, COM(17) 539 |
3.1After the financial crisis, the EU Member States made major changes to the regulation and supervision of their financial markets on a pan-European basis. Notably, they established the European System of Financial Supervision (ESFS) which involved the creation of three “European Supervisory Authorities” (or ESAs): the European Banking Authority (EBA),12 the European Insurance & Occupational Pensions Authority (EIOPA) and the European Securities & Markets Authority (ESMA). They have sector—and firm-specific—responsibilities covering the banking, insurance and securities markets respectively, and help oversee the uniform implementation of the EU’s post-crisis regulation of the financial services industry.
3.2The ESAs have far fewer direct supervisory responsibilities than national regulators like the Bank of England. Instead, they focus on assisting the European Commission in drafting technical regulations.13 Although the Authorities can—as a last resort—exercise powers to override a national regulator if they believe it is not properly applying EU financial legislation, this power has never been used: a decision to invoke such a ‘breach of Union law’ procedure must be taken by the Board of Supervisors of an ESA, where only the EU’s national regulators have voting rights.14
Review of the European System of Financial Supervision
3.3The European Commission carried out a comprehensive evaluation of the ESFS from 2014. This 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, override. It also concluded that other political developments necessitated a rethink of the Supervisory Authorities’ remit and powers to ensure uniform implementation of EU financial services law in all Member States.
3.4Principal among these developments was the UK’s decision to withdraw from the EU. Given the UK’s status as Europe’s largest financial centre, the Commission reasoned Brexit was likely to result in a substantial proportion of financial services within the EU being provided from a ‘third country’ that is not subject to EU law.15 Under existing European legislation, UK financial firms could continue to service EU-based customers under a variety of mechanisms to reduce the impact on market access resulting from the UK’s withdrawal from the Single Market, including:
- equivalence, where a non-EU country’s regulatory regime for specific financial products or services is can be formally declared equivalent to the EU’s by the European Commission, making it easier for those firms to access the EU market;
- outsourcing and delegation, where an EU-based firm—possibly a subsidiary of a UK firm—effectively contracts a UK entity to provide the actual services; and
- the establishment of branches in specific EU countries where they want to provide services, under the national legislation of those countries.
3.5In 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.16 In summary, these proposals would:17
- reinforce the role of the Supervisory Authorities in the ‘equivalence’ process, requiring them to advise the Commission when determining whether a specific ‘third country’ was equivalent, and help it monitor that country’s regulatory regime on an on-going basis to ensure equivalence is maintained thereafter;18
- give each ESA new powers to obtain data from national regulators about their supervision of ‘third country’ firms that effectively operate within the EU by means of outsourcing or delegation of activities by EU-based firms, to give the European Commission a clearer picture of the extent to which the provision of financial services are carried out subject to effective supervision under EU law;
- expand the powers of the European Securities & Markets Authority (ESMA),19 making it the responsible regulator for certain investor prospectuses, financial benchmarks and investment funds, stripping those supervisory powers from the Member States’ national regulators;20
- alter the ESA’s governance structures to make them more assertive vis-à-vis the Member States’ national financial regulators, notably by transferring the power to censure those regulators for mis-applying EU law—for example in relation to services provided by non-EU firms—to a new Executive Board (which would be made up wholly of independent members);21 and
- reform of the ESAs concerned the way in which they are funded. The Commission had suggested the Supervisory Authorities should charge a levy on firms within their remit to cover 60 per cent of their ESA’s running costs (which are currently met by annual contributions by the Member States’ national regulators), with the remainder being drawn from the EU budget.22
3.6In September 2018, the Commission added a further proposal to the ESFS review, with the aim of expanding the powers of the European Banking Authority to tackle money laundering (AML) following the various banking scandals involving European financial institutions. We cleared this from scrutiny in January 2019.23
State of play in the legislative process
3.7The Council adopted its position on the supplementary proposal related to anti-money laundering powers for the EBA on 22 January 2019. At that same meeting, the Finance Ministers of a “number of Member States” argued that they should agree on their common position on the entire ESFS review before negotiations with the European Parliament were undertaken (instead of opening such negotiations solely on the AML—related provisions, as had been the original plan). Another group of national Governments also expressed the view that the Council “was very close to reaching a compromise on the whole dossier at the end [2018]” and would have supported a General Approach at the ECOFIN Council on 22 January 2019 if one had been on the agenda.
3.8Given these political pressures, by letter dated 30 January 2019 the Economic Secretary to the Treasury (John Glen MP) therefore informed us that the Council had converged on a common position on the ESFS package as a whole. He expects this to be formally endorsed by EU Finance Ministers when they meet in Brussels on 12 February 2019.24 This was apparently despite a push by the UK for more time to be taken to discuss the proposals.
3.9Under the draft ‘General Approach’ that will be put to Finance Ministers on 12 February, a majority of Member States want to make significant changes to the original Commission proposals in a number of areas, including:
- Eliminating most of the proposed transfers of direct supervisory responsibilities from Member States to ESMA, except for critical benchmarks (which would leave the current domestic discretion on recognition of non-EU financial benchmarks intact), and financial markets’ data reporting service providers;
- Removing the proposed power for the EBA, ESMA and EIOPA to “approve or challenge” individual EU-based firms plans for outsourcing, delegation and risk transfer arrangements to firms based in non-EU countries;25
- Accept the principle of a larger role for the Supervisory Authorities in monitoring continued compliance with the conditions for equivalence by ‘third countries’ with EU financial services legislation, focussed on “implications for financial stability; market integrity; investor and consumer protection; the functioning of the internal market; relevant regulatory and supervisory developments and practices; and market developments relevant to a risk-based equivalence assessment”;26
- Scrap most of the suggested governance reforms for the ESAs, in particular the creation of new Executive Boards (which would have had substantial powers and be independent from the Member States’ national regulators). Instead, the Council is looking to add some external and independent members with clearly defined policy and managerial tasks to the Authorities’ existing Management Boards (whose powers are limited);27 and
- Remove the proposed industry levy to fund the activities of the ESAs, retaining the current system of national and EU contributions. However, there is no agreement yet on whether the contribution from the EU budget should remain at 60 per cent, as is currently the case.
3.10The Parliament’s Economic & Monetary Affairs Committee adopted its position on the ESFS reform proposals on 10 January 2019.28 The Minister’s letter does not indicate to what extent these changes to the Commission proposals, if endorsed by Finance Ministers, are also likely to be acceptable to the Parliament.
Next steps in the legislative process
3.11The ESA reform proposals are subject to the EU’s ordinary legislative procedure, meaning they must be agreed jointly between the Parliament and the Council to take effect. As we have noted, there are significant differences of opinion between the two institutions, some of which are highlighted in the Minister’s latest letter.
3.12If the EU Finance Ministers adopt their ‘General Approach’ later this month, the Romanian Presidency of the Council would begin so-called trilogue negotiations with MEPs on the final substance of the new legislation. How long those discussions will take is unclear at this stage. Both institutions are aiming for adoption of the legislation before the European elections in May 2019, although the Treasury has previously told us that the UK wants to “delay the main [ESFS] proposal from being agreed” before the European Parliament is dissolved in April, delaying its eventual entry into force.29
3.13One of the key areas of focus for the Government in the forthcoming trilogues is the European Parliament’s demand that ESMA should be given “direct supervision of third country Central Security Depositaries and Trading Venues” under the EU’s CSD Regulation.30 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.
3.14The outcome of the legislative process may still have a significant impact on the British financial services industry and regulators, irrespective of the political timetable and despite the UK’s scheduled withdrawal from the EU on 29 March 2019. We have reiterated our assessment on this point in our conclusions below.
Our conclusions
3.15We thank the Minister for the information on the negotiations for the reform of the EU’s financial Supervisory Authorities, and the areas of special concern to the UK.
3.16As we have noted in various previous Reports we remain concerned about the implications of the ESFS review for the UK despite its scheduled withdrawal from the European Union in March this year.
3.17If the Withdrawal Agreement is ratified,31 the UK would enter a post-Brexit transitional during which it would stay in the Single Market until at least 31 December 2020.32 During that time, EU law would continue to apply and EU bodies—including the financial Supervisory Authorities—would retain their powers in relation to the UK as if it were still a Member State. The key difference is that the Government would no longer have representation or voting rights at EU-level (meaning, for example, that the Bank of England and FCA would cease to be part of the ESA’s Boards of Supervisors). Any new powers the ESAs gain in the coming years—for example the transfer of supervisory responsibility for benchmarks or prospectuses from Member States to ESMA—would extend to the UK financial services industry while the transition is still in effect.
3.18The powers of the ESAs are also highly relevant for the UK even after it leaves the Single Market (for example at the end of any post-Brexit transitional period, or in the eventuality of a ‘no deal’ scenario on 29 March 2019).
3.19Firstly, Government has accepted that any preferential access for UK financial services firms to the EU market will be based on the ‘equivalence’ mechanism. As discussed, this would allow 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. As the ESFS review is likely to result in a greater role for the ESAs in preparing and monitoring equivalence decisions, both the Treasury and the industry itself will be following the negotiations with interest. We note in this regard that the Government is pushing for more “transparency” in the process of granting, modifying or withdrawal of equivalence decisions by the EU. The Political Declaration does not oblige the Commission to grant the UK equivalence where it is available under EU law: that decision lies with the Commission on a case-by-case, subject to a qualified majority vote among Member States.
3.20Secondly, the legislative reform of the ESAs is included in the scope of the Government’s Financial Services (Implementation of Legislation) Bill currently before Parliament. This Bill gives the Treasury the power to implement a number of pending EU legislative proposals in the field of financial services into UK law, in the event that the Withdrawal Agreement is not ratified (and EU law ceases to apply in the UK in March 2019).
3.21The Bill, if enacted, would enable the Treasury to make regulations to implement the ESA reforms domestically after they are formally adopted by the Council and the European Parliament. The inclusion of the ESFS review in the scope of the Bill seems counterintuitive, given that the proposals relate to the powers of EU bodies that, by definition, would have no jurisdiction over the UK in a ‘no deal’ eventuality. However, the Bill would enable the Treasury to implement the legislation “with any adjustments [it] considers appropriate”. We understand the Government has included the ESFS review in the Bill so that it can implement changes to allow financial markets to continue functioning as smoothly as possible. For example, it could make regulations allowing 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, rather than needing to pass primary legislation.
3.22For the reasons given above, the ESFS review is directly relevant to the UK financial services industry both before and after the UK leaves the Single Market. Given the potential implications of the proposals for the UK, we welcome the Minister’s indications that the Member States at least want to significantly alter some of the more far-reaching elements of the original Commission proposal (including mostly removing the proposed transfer of direct supervisory responsibilities from national regulators to ESMA).
3.23We ask the Minister to keep us informed of further developments in the legislative process, but are content to now grant the Government a scrutiny waiver enabling the Treasury to support a general approach on the proposals at the ECOFIN Council on 12 February 2019.
Full details of the documents
(a) Proposal for a Regulation on the European Supervisory Authorities: (39052), 12420/17 + ADD 1–2, COM(17) 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(17) 537; (c) Amendment of the proposal for a Regulation as regards the authorisation of CCPs: (39056), 12431/17, COM(17) 539.
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); Fourteenth Report HC 301–xiv (2017–19), chapter 7 (21 February 2018) and Fifty-First Report HC 301–l (2017–19), chapter 5 (16 January 2019).
12 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.
13 The ESAs have four broad sets of powers under EU law: drafting Technical Standards to give full effect to EU financial regulation; issuing non-binding guidelines, recommendations and opinions to both financial services providers and domestic regulators; fostering regulatory and supervisory convergence throughout the EU; and exercising direct supervisory powers, notably authorisation and ongoing supervision of specific types of financial firms.
14 The 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). Although day-to-day management of the ESAs is handled by Management Boards, they are also dominated by a sub-set of national supervisors, and they have few direct responsibilities.
15 The Commission also cited other developments, including the increased cross-border flows of capital as part of the Capital Markets Union, and the further integration of the European banking sector as part of the Banking Union.
16 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.
17 We described the substance of the Commission’s ESFS proposals in some detail in our previous Reports of 13 December 2017, 28 February 2018 and 9 January 2019.
18 In particular, the ESAs would submit a confidential report on their findings about continued equivalence of non-EU countries with EU financial services law to the Commission on an annual basis, which would use this information to decide whether to maintain, modify or withdraw equivalence.
19 ESMA 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).
20 The original Commission proposal would make ESMA the regulator responsible for European Venture Capital Funds (EuVECA),54 Social Entrepreneurship Funds (EuSEF) and Long-term Investment Funds (ELTIF), which are all specific types of investment funds whose legal framework is set out in EU Regulations.
21 At present, all important decisions taken by the ESAs are made by their Boards of Supervisors (BOS), which are made up of representatives of the Member States’ national regulators.
22 The ESAs get 60 per cent of their budget from National Competent Authorities’ (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).
23 See the Committee’s Report of 9 January 2019.
24 On 30 January 2019, the Minister said that a “number of Member States” argued earlier that month that a General Approach should be sought on the whole file before negotiations with the European Parliament were undertaken (which, at that stage, would have focussed on the AML elements only). Another group of Member States also expressed the view that the Council “was very close to reaching a compromise on the whole dossier at the end [2018]”, and would have supported a General Approach at the ECOFIN Council on 22 January 2019.
25 Under the Commission proposals, the ESAs would not have been able to block any such arrangements except via a breach of Union law procedure (which, as noted, has never been used).
26 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”.
27 The ESA’s Management Boards are responsible for their day-to-day management. Like the Boards of Supervisors, they are also dominated by (a sub-set of) Member States’ national financial regulators, and they have few direct responsibilities. Under the Council’s general approach, the Board of Supervisors of the ESAs would have to discuss decisions relating to ‘breach of Union law’ procedures when two members object to use of a written procedure. The procedure for actually declaring a breach would remain unchanged.
28 European Parliament document A8–0013/2019.
29 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.
30 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
31 Ratification of the Withdrawal Agreement remains highly uncertain in light of the vote in the House of Commons on 29 January 2019 instructing the Prime Minister to re-open negotiations with the EU.
32 Under Article 135 of the Withdrawal Agreement, the transition could be extended until 31 December 2022.
Published: 12 February 2019