Documents considered by the Committee on 13 December 2017 Contents

9European System of Financial Supervision

Committee’s assessment

Legally and politically important

Committee’s decision

Not cleared from scrutiny; further information requested; drawn to the attention of the Treasury Committee

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

Legal base

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



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

Summary and Committee’s conclusions

9.1The European Commission in September 2017 proposed substantial reforms of the functioning of the EU’s financial supervisory authorities (the ESAs) for the banking, insurance and investment industries. As we set out in more detail in “Background” below, 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’ national financial regulators; and impose a new industry levy to fund their work.

9.2It is clear from the Commission’s Explanatory Memorandum that the UK’s withdrawal from the EU has driven these proposed reforms, at least in part. There are concerns that UK financial services firms might try to establish “letter box” entities in the EU, servicing EU-based clients from the UK without substantially moving their operations to an organisation within the Single Market as required by EU law. This, the Commission argues, increases the need for stronger ESAs which can ensure that all Member State regulators apply the EU’s regulatory requirements for “third country” firms in the same way.

9.3The Economic Secretary to the Treasury (Stephen Barclay) submitted an Explanatory Memorandum on the proposals in October 2017.33 It provides virtually no substantive assessment of the proposed changes. It does not reflect on the implications of the proposals for the UK financial services industry after Brexit, or during the “implementation period” after March 2019 during which the UK would remain subject to EU law but without formal political representation within the EU institutions and bodies, including the ESAs.

9.4The proposals are of major political and legal importance, substantially altering the European System of Financial Supervision as it was created seven years ago and expanding the powers of the Supervisory Authorities. In paragraphs 9.73 to 9.100 below, we have made an initial assessment of the proposals, in particular in the context of Brexit. In summary, we are most concerned about the proposal to allow the ESAs to set supervisory priorities for domestic financial regulators; the increased responsibilities of ESMA; the consequences of the post-Brexit “implementation period” for the formal representation of the UK’s domestic financial regulators at EU-level; and the implications of new powers for the ESAs in relation to firms established outside the EU (which will become relevant once the UK becomes a “third country” vis-à-vis the Single Market).

9.5Given the paucity of the Minister’s original Memorandum, we ask him to write to us with the Government’s substantive assessment of the proposals. His reply should cover at least the points listed below relating to the substance of the Commission proposals, the implementation period and the role of the ESAs once the UK becomes a “third country”.

The substance of the Commission proposals

9.6As noted in paragraphs 9.94 to 9.100, the Government’s position on the Commission proposals is not clear. We would therefore like the Minister to clarify his views on:

The ESAs during the “implementation period”

9.7In relation to the post-Brexit “implementation period”, during which EU law would continue to apply in the UK (see paragraphs 9.79 to 9.86), we ask the Minister to explain:

The ESAs and the UK as a “third country”

9.8Lastly, the Commission proposals would alter the ESAs’ role where third country firms seek permission to operate within the Single Market (see paragraphs 9.87 to 9.93 below). We would like the Minister to clarify the Government’s position on:

9.9We expect a comprehensive reply from the Minister addressing our concerns about the implications of these proposals by 12 January 2018. We will also consider inviting him to give evidence to us in person, especially in relation to the implications of the transitional period and any subsequent UK-EU agreement on financial services for the parliamentary scrutiny process.

9.10In the meantime, we retain these documents under scrutiny. We also draw these developments to the attention of the Treasury Committee.

Full details of the documents

(a) Proposal for a Regulation amending Regulation (EU) No 1093/2010 establishing a European Supervisory Authority (European Banking Authority); Regulation (EU) No 1094/2010 establishing a European Supervisory Authority (European Insurance and Occupational Pensions Authority); Regulation (EU) No 1095/2010 establishing a European Supervisory Authority (European Securities and Markets Authority); Regulation (EU) No 345/2013 on European venture capital funds; Regulation (EU) No 346/2013 on European social entrepreneurship funds; Regulation (EU) No 600/2014 on markets in financial instruments; Regulation (EU) 2015/760 on European long-term investment funds; Regulation (EU) 2016/1011 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds; and Regulation (EU) 2017/1129 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market: (39052), 12420/17 + ADD 1–2, COM(17) 536; (b) Proposal for a Directive amending Directive 2014/65/EU on markets in financial instruments 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 pending proposal for a Regulation amending Regulation (EU) No 1095/2010 establishing a European Supervisory Authority (European Securities and Markets Authority) and amending Regulation (EU) No 648/2012 as regards the procedures and authorities involved for the authorisation of CCPs and requirements for the recognition of third-country CCPs: (39056), 12431/17, COM(17) 539.


9.11The EU made major changes to the supervision of the financial markets of its Member States in response to the 2008 financial crisis. Notably, it created the European System of Financial Supervision (ESFS). The ESFS is built on a two-pillar system of macro-prudential and micro-prudential supervision (conducted at EU-level by the European Systemic Risk Board (ESRB) and the European Supervisory Authorities respectively, and at Member State level by the relevant domestic financial authorities).35 The EU-level institutions became operational in 2011.

9.12The European Commission carried out a comprehensive evaluation of the ESFS in recent years, which has highlighted concerns about the governance and effectiveness of the ESAs in using their existing powers.36 In addition, since the ESFS was created, the EU has taken significant steps towards a Banking Union for the Eurozone, which concentrated supervisory responsibility for large banks in the European Central Bank and created a Single Resolution Mechanism for failing institutions.37 It has also begun creating an EU-wide Capital Markets Union to increase businesses’ access to non-bank finance from other Member States.38 The increased cross-border financial flows implied by these developments are not, the Commission says, reflected by the ESAs’ current remit or powers.

9.13The UK’s withdrawal has also prompted a rethink of the EU’s approach to financial regulation, in particular as regards supervision of UK companies that may seek to service customers within the Single Market after Brexit.

9.14In the light of these developments, the Commission in September 2017 tabled a package of proposals to amend the 2010 Regulations which established the ESRB and the ESAs. We have set out the current functioning of the ESAs below, before discussing in more detail the substance of the new Commission proposals. We have covered a proposal relating to the European Systemic Risk Board in a separate Chapter in this Report.39

The European Supervisory Authorities

9.15At EU-level, the micro-prudential pillar of the ESFS consists of the three European Supervisory Authorities: the European Banking Authority (EBA) in London;40 the European Insurance & Occupational Pensions Authority (EIOPA) in Frankfurt; and the European Securities & Markets Authority (ESMA) in Paris.

9.16The ESAs, whose founding Regulations are largely identical, have four broad sets of powers:

9.17In addition, the ESAs contribute to individual Colleges of Supervisors, the formalised structure within which the domestic regulators of a specific cross-border financial services provider discuss their supervisory approach to that entity.

The Commission proposals

9.18The European Commission’s legislative proposals are a complex package of measures to address the shortcomings it identified relating to the powers, governance and funding of the European Supervisory Authorities.

9.19With respect to the ESAs, there are three linked proposals. Their objective is to adjust and upgrade the ESAs framework, to ensure the Authorities can assume an enhanced responsibility for financial market supervision by making sure they are “adequately equipped in terms of powers, governance and funding”. Collectively, they seek to make changes to twelve existing Regulations and Directives. The three legislative documents are:

9.20We have assessed the substance and implications of the ESA proposals below, drawing on the Explanatory Memorandum submitted by the Economic Secretary to the Treasury (Stephen Barclay) on 16 October 2017.49

Reform of the European Supervisory Authorities

9.21The Commission argues that, while the ESAs “have played a key role in ensuring that the financial markets across the EU are well regulated, strong and stable”, its evaluation has shown that there “remains significant potential to enhance regulatory and supervisory convergence within the EU”. It is seeking to address this primarily by changing the ESAs’ governance and funding structures, to make them less reliant on the instructions and funding from the National Competent Authorities (NCAs).

9.22It also concluded that the UK’s exit from the EU increased the need for a coherent supervisory approach to third country firms seeking access to the EU market, to ensure British firms would not seek to establish themselves in the Member State with the least intrusive regulatory approach after Brexit to preserve their current activities without substantially transferring operations into the EU.50

9.23Moreover, in view of the proposed further integration of the Union’s financial markets under the Banking and Capital Markets Unions, the Commission warns that increased financial integration also expands the channels of contagion between Member States in the event of adverse shocks, such as those experienced during the 2008 crisis. It therefore wants to give the Supervisory Authorities a stronger role (and, in certain cases, direct supervisory responsibilities) to ensure that increased cross-border activity is effectively monitored.

ESA powers

9.24As noted above, the European Commission is of the view that the current mechanisms used by the ESAs to ensure that NCAs apply EU law in consistent way need to be strengthened. It has also proposed to give them additional powers to ensure cross-border activities are supervised effectively.

9.25The proposed strengthening of the ESAs’ powers takes several forms:

9.26We set out the substance of the proposals in more detail below.

Supervisory convergence and coordination

9.27One of the key tasks of all three ESAs is to “actively foster supervisory convergence across the Union with the aim of establishing a common supervisory culture”. In view of the envisaged degree of financial integration among EU Member States, the Commission wants to give the Authorities more powers to promote such convergence.

9.28In particular, the Commission wants to require the ESAs to set EU-wide priorities for supervision in the form of a “Strategic Supervisory Plan” (SSP), against which all competent authorities will be assessed. As part of this process, NCAs would have to draw up annual work programmes in line with the Strategic Plan. In addition, peer reviews conducted between NCAs would become “independent reviews” with less direct involvement of the staff of the domestic regulators themselves, to “enhance the value added of these reviews and to insure impartiality”. The Commission also proposes to allow the ESAs to request information from a broader range of third parties, for example if it suspects an NCA is not applying EU law properly. The Authorities would also be given the power to impose fines when a company fails to provide such information.

9.29A separate element of the proposals would substantially alter the governance arrangements of the ESAs to make it easier for them to use their supervisory convergence powers across the board. These changes are set out in more detail in paragraphs 9.59 to 9.68 below.

9.30In his Explanatory Memorandum, the Minister did not comment specifically on the SSP, the “independent reviews” or the new ESA powers to request information. He states that “any proposals to reduce inconsistencies in regulatory or supervisory practice between EU Member States should be proportionate to the risks posed”, and, presumably referring to the Commission’s concerns about the activities of UK firms after Brexit, “should not discriminate against the UK”.

Supervision of non-EU firms active on the EU market

9.31The Commission proposals also contain several provisions on the supervision of firms operating within the EU, but which are based in—or have outsourced functions to—non-EU countries.

9.32First, the proposals reinforce the role of the Supervisory Authorities in the equivalence process. Under certain pieces of sectoral financial legislation,51 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.52 In such cases, companies based in the country in question can apply to provide services throughout the Single Market without the need to establish a subsidiary within the EU (although it falls well short of the system of mutual recognition inherent in the “passporting” regime applicable to firms established within the Single Market, for example in terms of the type of service that can be offered or the type of client that can be targeted).

9.33The Commission has proposed to formalise the role of the ESAs in providing advice to it 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 which have an equivalence decision in place. They would submit a confidential report on their findings to the Commission on an annual basis, which will use this information to decide whether to maintain or withdraw the equivalence decision.53 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.

9.34Secondly, most likely in response to the UK’s withdrawal from the EU, each Supervisory Authority will gain new powers to obtain information from national regulators about authorisation or registration of financial firms whose business plan “entails the outsourcing or delegation of a material part of its activities or any of the key functions or the risk transfer of a material part of its activities into third countries, to benefit from the EU passport while essentially performing substantial activities or functions outside the Union”.

9.35The information should enable the ESAs to assess whether the latter are effectively supervising outsourcing, delegation and risk transfer arrangements in third countries, and do not result in the circumvention of EU rules on applicable prudential and conduct requirements. However, the ESAs will not be able to override the decision of a national authority to approve such arrangements.

9.36Lastly, the Commission has proposed a substantial expansion of the direct supervisory powers of ESMA in relation to a number of investment-related products and services, some of which concern products or services offered to EU-based customers by third country companies. These amendments are explained in more detail below.

9.37The Minister’s Explanatory Memorandum does not summarise the Government’s position on these proposals, or offer an assessment of their implications for UK firms after Brexit.

New powers for ESMA

9.38The final major element of the Commission proposals on the powers of the ESAs is a substantial expansion in the direct supervisory responsibilities of ESMA.54

9.39ESMA is the responsible EU-level Supervisory Authority for EU sectoral 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). A common thread that runs through these sectoral laws is that they typically create a framework for market participants to operate across the Single Market, but have kept supervisory responsibility for market participants at Member State level.

9.40In addition to the general risk of divergent application of the relevant legislation by different competent authorities, the Commission expresses concerns that this is leading to “forum shopping”:

“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.”55

9.41Moreover, the Five Presidents’ Report on Completing Europe’s Economic and Monetary Union of June 2015 set the objective of, ultimately, a single capital-markets supervisor for the entire EU.56 In light of these developments, the Commission is now proposing to increase the direct supervisory responsibilities of ESMA to ensure greater consistency in the application of EU law and reduce the risk of regulatory arbitrage or forum shopping.

9.42As with the other aspects of these Commission proposals, the Minister’s Explanatory Memorandum failed to offer any meaningful insights into the Government’s position on ESMA’s potential new powers. However, given their significance, we have described them in more detail below.

Markets in financial instruments

9.43Effective supervision of investment firms by the NCAs and ESMA depends on the level of information they have on market activity, for example to help them identify market abuse. Access to such data also improves market transparency for investors, increasing choice and reducing cost.

9.44The second Markets in Financial Instruments Directive (MiFID II), which takes effect on 1 January 2018, seeks to improve the quality and accessibility of such data in a standardised way.57 In particular, it requires data reporting services providers (DRSPs) to be authorised by an EU Member State’s financial regulator and submit data in a standardised format.

9.45The Commission now argues 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 wants 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.

9.46The Commission has therefore proposed to make ESMA directly responsible for the authorisation and supervision of data reporting services, and give the Authority the power to request information from market participants and NCAs to fulfil its supervisory tasks.

Benchmarks Regulation

9.47Following the LIBOR and EURIBOR manipulation scandals, the EU adopted a Regulation to govern the accuracy and integrity of benchmarks used in financial contracts.58 Under Article 29 of that Benchmarks Regulation, supervised entities such as banks, investment firms and insurance companies can only use a benchmark if its administrator is registered with ESMA and fulfils the requirements laid down by the Regulation.

9.48For benchmarks administered by organisations based in a non-EU country, registration with ESMA normally requires an equivalence decision by the European Commission (recognising the regulatory regime of the third country in question as equivalent to the Benchmarks Regulation) and for the competent authority of that country to have concluded a cooperation agreement with ESMA.

9.49However, given the widespread use of third country benchmarks in EU markets,59 Article 32 allows specific third country administrators to ask for “prior recognition” by the competent authority of an EU Member State. If such recognition is granted, which is conditional on compliance with the Regulation, its benchmarks can be used by supervised entities in the EU without registration. However, third country benchmarks already in use in June 2016 can be used until June 2020 as a transitional measure without requiring to go through this process.

9.50Under the Regulation as it stands, ESMA coordinates the supervision of benchmark administrators by national competent authorities, and for “critical benchmarks”, participates as a full member in the college of national supervisors which decides on a joint supervisory approach. However, under the Commission proposal, supervision of critical benchmarks60 and all benchmarks administered from outside the EU (but used within it) would become the direct responsibility of ESMA. This includes responsibility for granting recognition or endorsement to third country administrators in the absence of an equivalence decision. As a result, national authorities would lose the ability to grant such recognition.

Prospectus Regulation

9.51To 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,61 which will replace the existing Prospectus Directive62 from July 2019.

9.52At present, the competent authorities of the Member States are responsible for approving prospectus documents before they can be marketed to investors. Prospectuses approved in this way by one country are automatically valid throughout the EU. The Commission now proposes to transfer the supervision of certain types of prospectuses to ESMA.63 This means the Authority, rather than national supervisors, would be responsible for scrutinising and approving such documents before their publication.

9.53Similarly, ESMA would be responsible for prospectuses submitted under the Regulation by companies based outside the EU. It would also take over responsibility for approving prospectuses aimed at EU investors drawn up under the laws of a third country (which will still only be permitted if that country’s regulatory regime has been legally declared equivalent to the EU’s, and it has a cooperation agreement with ESMA in place).


9.54The recent EU Regulations on investment funds for venture capital (EuVECA), social entrepreneurship (EuSEF)64 and long-term investments (ELTIF)65 introduced specialised fund structures to make it easier for market participants to raise and invest capital in innovative small and medium-sized enterprises, social undertakings and long-term infrastructure projects throughout Europe. However, supervisory responsibility was given to national authorities. The Commission argues that the divergent practices of those authorities in applying administrative requirements at the point of registration or during subsequent supervision of these Funds has created an “uneven playing field”.

9.55Although the Commission concedes that “the majority of the limited number of stakeholders replying [to its consultation question] on direct supervision of the asset management industry” saw NCAs as “better placed to perform this function”, it is nonetheless proposing to transfer supervisory responsibilities—including authorisation and supervision—over these Funds from national authorities to ESMA, which will “support the objectives of those Regulations as it will further facilitate the integration, the development and marketing of such fund structures across borders”.

9.56However, this creates a complication for Funds which have EuVECA or EuSEF designation, but which hold more than €500 billion (£440 billion) in assets under management. By law, they must be managed by a fund manager authorised and supervised by their national competent authority under the Alternative Investment Fund Managers Directive (AIFMD). To avoid the relevant entities from being jointly supervised by both ESMA and a national authority for the same fund, 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.66

Other proposed changes

9.57In addition to the above, there are miscellaneous proposed changes to the ESAs’ powers. These include permitting all three Supervisory Authorities to publish the stress test results of individual financial institutions,67 and giving EIOPA a greater coordinating role in ensuring that national regulators assess insurers’ internal models68 in a consistent way.

9.58With respect to the latter proposal, the Minister notes in his Explanatory Memorandum that “internal risk models used by insurance undertakings must reflect their particular circumstances, and the Prudential Regulation Authority (PRA) is best-placed to assess the appropriateness of an UK insurance undertaking’s internal model in relation to its obligations under Solvency II”.

ESA governance

9.59The European Commission’s evaluation of the ESFS found that the ESAs would benefit from stronger governance arrangements to enable them to use their powers to foster supervisory convergence between the NCAs more effectively.

9.60Notably, the ESAs have the power (under the so-called “breach of Union law” procedure) to identify and address inadequate application of the EU legislation within their remit as applied by the NCAs, which can culminate in the imposition of requirements on specific financial institutions to alter their practice if the relevant national authority fails to act.69 The ESAs can also act as binding arbitrator in dispute settlement between NCAs, and they can organise peer reviews to establish how different NCAs approach the same supervisory tasks.

9.61However, since 2011 no breaches of EU law have been declared and no dispute settlement cases with a binding outcome have taken place.70 The Commission has highlighted that the decision-making powers of the ESAs rests with their respective Board of Supervisors (BoS), on which only the Member States’ national competent authorities have a vote.71 Moreover, NCA peer reviews are carried out by panels comprised mainly of staff from the domestic regulators themselves. Although day-to-day management of the ESAs is handled by Management Boards, they are also dominated by a sub-set of NCAs, and they have few direct responsibilities.72

9.62As a consequence, the national regulatory authorities have a substantial influence over ESA decisions that may affect themselves or their domestic market.73 The Commission argues this is the reason the ESAs have been reluctant to use their powers to foster supervisory convergence between NCAs. It has also noted 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”.

9.63The Commission also highlights the need to bolster the ESAs’ ability to ensure a common supervisory approach in the context of Brexit. This reflects concerns that UK-based firms, which currently benefit from the market access arrangements provided by the Single Market, may try to establish “letterbox companies” in those Member States with the least-intrusive level of regulation to provide services to EU-based customers mostly or wholly from the UK.74 This, in the eyes of the Commission, requires divergent supervisory practices to be addressed as a matter of urgency to ensure that UK firms that continue to operate within the Single Market after Brexit are effectively supervised and compliant with EU law, irrespective of their host Member State.75

Governance reform

9.64To address these perceived governance shortcomings, the Commission has proposed to replace the Authorities’ Management Boards with new Executive Boards, which would have full-time members appointed by the Council after approval of a shortlist by the European Parliament, rather than being dominated by the NCAs.76 The Executive Board would take over some key decisions from the Board of Supervisors, such as those relating to dispute resolution between competent authorities, breaches of EU law, and the new independent reviews, as well as deciding on the initiation of stress tests.

9.65The Executive Boards would also be in charge of setting out supervisory priorities for the national competent authorities in the new “Strategic Supervisory Plan” (SSP; see paragraph 9.28 above). They would check the consistency of the work programmes of competent authorities with EU priorities and review their implementation. For ESMA, in situations where it will exercise 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.

9.66The Commission has also proposed a slightly different approach for the supervision of central counterparties (CCPs), which protect both counterparties to an over-the-counter derivatives trade from the default of the other.

9.67A separate proposal from June 2017,77 still under consideration within the Council and Parliament, would establish a new body within ESMA called the CCP Executive Session. This body would be responsible for handling tasks related to central counterparties in general, as well as the authorisation and supervision of CCPs. As part of the ESA reforms, the Commission has put forward an amendment to that pending proposal to clarify that the indirect supervisory powers of ESMA relating to CCPs (such as breach of EU law procedures or commissioning independent reviews) would lie with that Executive Session, and not with its general Executive Board or Board of Supervisors.

9.68The Minister’s Explanatory Memorandum does not put forward the Government’s position on any aspect of these proposed governance reforms, or offer a view on the Commission’s concerns that Brexit necessitates further supervisory convergence within the EU-27.

ESA funding arrangements

9.69The final element of the ESA reform package concerns the way in which the Authorities are funded. At present, the ESAs are resourced through obligatory contributions from the national competent authorities,78 a subsidy from the EU budget, and—in the case of ESMA—fees paid by market participants subject to direct supervision.79

9.70The Commission has taken the view that, in light of the proposed changes to the ESAs’ powers and governance structures, the way in which the Authorities are funded also needs to be reviewed to ensure that they have the necessary resources to fulfil all their tasks. The Commission notes that their workload is likely to increase further when they have to “deal with third country issues for several markets and entities that are operating from the United Kingdom” after Brexit.80

9.71The Commission therefore proposes that, instead of collecting contributions from the NCAs, the ESAs will charge a levy on indirectly supervised 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. The direct contribution by NCAs would be eliminated entirely. The industry levy would be set on an annual basis, based based on the estimated workload for each Authority for each category of market participants.81

9.72In his Explanatory Memorandum, the Economic Secretary notes that “the proposals for increased industry funding will…be contentious, and…unlikely to be supported by the financial services sector”. However, the Minister failed to explain the Government’s position on the shift from NCA contributions to an industry levy.

Our assessment

9.73These proposals are important, both because of the substantive changes they seek to make to the current European system of financial supervision, and because the extension of ESA responsibilities in relation to third countries will become relevant to the UK after it ceases to be an EU Member State.

9.74The Committee is concerned that the proposals go further than necessary in a number of ways. In particular:

Implications of Brexit

9.75The proposals also have clear Brexit implications. When the UK leaves the EU, it will become a third country for the purposes of EU law. As we noted in our letter to the Economic Secretary of 22 November 2017, this new status as a non-EU country has significant implications for the ability of UK-based financial services providers to market and offer their services to EU-based customers.

9.76The exact implications of the UK as third country vis-à-vis the Single Market are different for each sector of its financial services industry. Once outside the EEA, UK firms will lose the “passport” that allows them to provide cross-border services to any EEA Member State without seeking authorisation in the countries concerned. In certain cases, a non-EU country like the UK can apply for a determination that its regulatory regime is equivalent to the EU’s, after which its providers apply to sell their services into the EU without being based there (see paragraph 9.32 above). The Commission has now proposed to give the ESAs a larger role in scrutinising the regulatory regimes of third countries before such equivalence can be established, as well as a monitoring role afterwards to ensure that equivalence is maintained in practice. These new procedures would also apply to the UK, should they be in force if and when the Government applies for specific equivalence decisions.

9.77However, the “third country” and equivalence provisions in EU financial services law may not apply to the UK immediately in March 2019, when the two-year withdrawal period under Article 50 TEU ends. The Prime Minister has called for a temporary post-Brexit “implementation period” during which the UK’s market access to the EU on current, Single Market terms would be maintained. In return, the UK will have to apply EU legislation, including new laws that enter into force during that period, and accept the jurisdiction of the European Court of Justice.83

9.78The package of Commission proposals on the functioning of the European Supervisory Authorities is therefore doubly relevant: during the “implementation period”, this new legislation may apply in the UK despite formal withdrawal from the EU; in the longer term, the new powers for the ESAs—in particular ESMA with respect to new direct supervisory responsibilities for third country firms—may shape how the UK financial services industry engages with both regulators and customers based in the EU post-Brexit. We will address both aspects in turn.

ESA reform and the “implementation period”

9.79The Government is seeking a post-Brexit “implementation period”, during which the UK would remain in the “existing structure of EU rules and regulations”.84 Although it has not explicitly confirmed the proposed scope of this arrangement, we presume that—in view of the position of the EU-27—the UK would remain bound by all EU financial services legislation during this period.85 If not, it is unlikely that UK-based firms would be able to access the EU’s markets on the same conditions as at present, which is one of the Prime Minister’s objectives for the arrangement.

9.80While in one respect this transitional period would delay the “cliff edge” of UK firms becoming third country entities for the purposes of EU financial services legislation, it raises another set of difficult questions with respect to the participation of the UK’s domestic financial regulators in the work of the ESAs.

9.81The NCAs play a major role in the functioning of the European Supervisory Authorities. As ex officio members of each Board of Supervisors, they have ultimate control over the appointment of the Chair of each Authority and the adoption of its budget, the issuance of draft regulatory standards to the Commission, and taking of decisions relating to dispute settlement and breaches of EU financial services law. It is likely that the Bank of England and the Financial Conduct Authority are influential players on the Boards, given the UK’s large financial services sector and their wealth of technical expertise.

9.82After March 2019, the UK regulators will no longer be members of the Boards of EIOPA, ESMA or the EBA, as membership of the Boards of Supervisors is restricted specifically to the competent authorities of EU Member States.86 In addition, UK experts would no longer attend meetings where new regulatory or implementing technical standards are drafted, or be able to attend Council working parties on new Directives or Regulations affecting the ESAs.

9.83However, conversely, it is not clear that the ESAs would lose their existing powers in relation to the UK’s domestic regulators and firms during this transitional period. With respect to the former, this is because the broader definition of “competent authority” used to establish the scope of the ESAs’ powers with respect to the NCAs (e.g. investigations for breaches of EU law, binding dispute settlement, and conducting peer reviews) could still apply to the UK NCAs during this period.87 In addition, ESMA’s direct supervisory powers would presumably apply to British firms for the duration of the implementation period as the relevant sectoral legislation would remain in effect in the UK.

9.84Such a situation would clearly be highly problematic, as the regulators representing Europe’s largest financial services industry would remain bound by EU law but have less say over the work of the ESAs than regulators from countries with much smaller financial sectors. However, the Minister did not indicate in his Memorandum whether this is, indeed, the logical consequence of the transitional arrangement sought by the Government. We consider it unlikely that the other Member States would consent to the UK effectively remaining in the Single Market for financial services, but exempt its regulators from the same EU-level oversight as their domestic authorities.

9.85These Commission proposals, if they enter into force during the implementation period, would exacerbate the gap between the UK’s representation and the extent to which it is affected by the ESAs:

9.86The implications of the UK being subject to the EU’s regulatory structures without its seat at the table within the ESAs are hard to quantify. However, plainly the influence of the UK’s domestic regulators at EU-level would diminish. It could be mitigated to some extent if the UK’s regulators were at least granted observer status on the Boards of Supervisors, in the same manner as the financial regulators of the EFTA-EEA states.88 Ideally, the Bank of England, Prudential Regulation Authority and the Financial Conduct Authority should retain their voting rights on the ESA Boards of Supervisors during the transitional period.

Situation following the “implementation period”

9.87After the end of the transitional period, should one be agreed, the UK will assume full “third country” status vis-à-vis the EU. In principle, at that point the ESA Regulations and sectoral financial legislation will cease to apply directly in the UK, and UK domestic regulators will no longer be part of the ESFS.

9.88This means that the European Supervisory Authorities will no longer have any legal powers to compel the UK’s domestic regulators to take certain actions or provide information. Similarly, UK regulators would cease to have any formal input into the works of the ESAs. To the extent that they were still represented (see above), the UK’s NCAs would cease to be members of the Boards of Supervisors, the Management Boards and any relevant Colleges of Supervisors. As we have described above, Brexit will also substantially alter the terms on which British firms can provide financial services to EU-based clients without establishing a subsidiary within the Single Market.89

9.89The legislative proposals we have described in this Report would increase the role played by the ESAs in acting as gatekeepers with respect to UK financial services providers seeking to access the Single Market after Brexit.

9.90The first set of these changes relates to the equivalence process. It is unclear whether the Government would, in the long-term, seek to obtain equivalence decisions for specific financial sectors.90 We are awaiting a reply from the Economic Secretary to the Treasury on this point.91 However, given the inherent difficulties in negotiating a bespoke trade agreement on financial services with the EU,92 equivalence must be regarded as the most realistic fall-back option.

9.91As these proposals make changes to the way the ESAs are involved in the equivalence process, they are clearly relevant in the Brexit context. The Authorities would have to “monitor regulatory and supervisory developments and enforcement practices and relevant market developments” in the UK, and submit a confidential report on its findings to the Commission on an annual basis (based on which the Commission would decide whether to maintain or withdraw the relevant equivalence decision).

9.92In addition, the Commission is seeking to establish a right for the European Supervisory Authorities to demand information from the Bank of England and the Financial Conduct Authority, and perform inspections with UK firms after Brexit, in return for an equivalence decision on the post-Brexit regulatory regimes. While the UK will not be under a legal obligation to agree to such arrangements, such a refusal would make it less likely that equivalence is granted.

9.93The second set of Brexit-related proposals are the expansion of ESMA’s direct supervisory responsibilities for third country financial benchmarks used within the EU (see paragraph 9.47) and the publication of prospectuses within the EU by non-EU companies (see paragraph 9.51). With the information provided by the Minister, we are unable to ascertain to what extent this is likely to significantly affect the situation for UK companies after Brexit compared to the existing third country provisions under the Benchmark and Prospectus Regulations. It is clear, however, that it will limit the options for administrators of benchmarks seeking recognition, as they would always have to apply to ESMA rather than a domestic regulator of an EU Member State.

Assessment of the Minister’s Explanatory Memorandum

9.94The Minister’s Memorandum does not make clear the Government’s position on the lion’s share of the proposals put forward by the Commission. We cannot reconcile this complete absence of information with the Government’s own assertion, repeated in the Memorandum, that “until exit negotiations are concluded (…) the Government will continue to negotiate, implement and apply EU legislation”.

9.95The Memorandum also made no attempt to place the proposals in the context of Brexit. It is clear from the Commission’s documents that it has taken the view that some UK firms will try to circumvent the application of EU regulatory standards to their operations while maintaining their current levels of access to EU clients after Brexit. In view of the UK’s high standards of financial regulation and supervision, and as the substance of the relevant EU legislation is due to be retained or transposed into UK law through the (EU Withdrawal) Bill, we do not believe such suspicions are warranted.

9.96Irrespective of our view, the concerns obviously are real. Yet, we do not know how the Government is trying to approach these issues. The Minister’s Explanatory Memorandum does not refer in substance to the way in which Brexit is driving much of these proposals. He has not indicated whether the UK would accept these new “administrative arrangements” in return for equivalence, or assessed the implications of ESMA’s new direct supervisory powers. He concludes his Memorandum by saying that “further technical analysis of this ambitious and complex omnibus proposal will be required in the context of the forthcoming negotiations on EU withdrawal”.

9.97In addition, the Minister has again made no reference to the Government’s own ambitions for the future UK-EU trade agreements on financial services. The Treasury, as outlined in the Chancellor’s Mansion House speech in June 2017, is seeking “a new process for establishing regulatory requirements for cross-border business between the UK and EU. It must be evidence-based, symmetrical, and transparent”.93

9.98We do not know to what extent this new joint regulatory approach would need institutionalised cooperation between the UK regulators and their EU counterparts, including the ESAs, and how this would be affected by the current proposals. The Government has recently confirmed it will seek to retain non-voting UK membership of at least one EU agency after Brexit.94 Whether that objective also applies to the ESAs is unclear, but their Regulations do not currently allow for third country participation outside of the EEA framework.95

9.99These are crucial issues, with important implications for the level of post-Brexit regulatory and legislative alignment the Government will maintain with the EU. While we appreciate that the ESA reform proposals are complex and politically sensitive, the Minister’s Memorandum failed to meet the Government’s own criterion that it should “present a clear account of the principal issues from a UK viewpoint, (…) providing the Government’s own analysis and position”.96 In addition, since we received the Memorandum, the Secretary of State for Exiting the EU has provided us with a guarantee that “EU exit implications are set out as fully as we can in future Explanatory Memoranda”.97

9.100With the information available to us currently, we are unable to assess the implications of these documents, especially how they might affect UK-EU trade in financial services after Brexit. The Committee takes the potential implications of continued regulatory alignment with the EU after Brexit, without UK political representation in EU bodies and agencies, extremely seriously. We have therefore retained the proposals under scrutiny, and asked the Minister to write to us setting out the Government’s position on the substance of these documents, including the “EU exit implications” (both during the transitional period, and for the UK as a “third country”).

Previous Committee Reports


33 Explanatory Memorandum submitted by HM Treasury (16 October 2017).

34 See paragraph 9.54 for more information on the proposed new ESMA supervisory powers over Alternative Investment Funds (AIFs).

35 In the UK, the participating national competent authorities (NCA) are the Bank of England and the Prudential Regulation Authority, the Financial Conduct Authority, and the Pensions Regulator.

36 European Commission, “Consultation on the review of the European System of Financial Supervision” (April 2013).

37 See Regulation 1024/2013 for the Single Supervisory Mechanism (cleared from scrutiny on 23 January 2013) and Regulation 1093/2013 for the Single Resolution Mechanism (cleared from scrutiny on 26 March 2014). A proposal for a pan-Eurozone deposit guarantee scheme remains under discussion but is unlikely to be adopted in the near future (see our predecessors’ Report of 7 September 2016).

38 As part of the Capital Markets Union, the Parliament and Council have adopted a new Prospectus Regulation and securitisation standards. In 2018, the Commission is expected to table further legislative proposals to complete the CMU.

39 See chapter 11 of this Report.

40 The EBA will relocate to Paris by March 2019 following the UK’s decision to withdraw from the EU. A Commission proposal to that effect remains under scrutiny.

41 ESA Regulatory Technical Standards, if adopted by the Commission, take the form of Delegated Acts. Their aim is to “ensure consistent harmonisation” of EU financial services legislation.

42 Implementing Technical Standards, if adopted by the Commission, take the form of Implementing Acts.

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

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

45 See Regulation (EU) No 648/2012 (EMIR).

46 See Commission document COM(17) 536.

47 See Commission document COM(17) 537.

48 See Commission document COM(17) 539.

49 Explanatory Memorandum submitted by HM Treasury (16 October 2017).

50 SWD(17) 308, p. 50.

51 For example, the EMIR Regulation, the Markets in Financial Instruments Directive and the Capital Requirements directive. However, equivalence is not available in many other sectors of the financial services industry covered by EU legislation.

52 See Commission document SWD(2017) 102 for more information on equivalence in EU financial services legislation.

53 Equivalence decisions can be unilaterally withdrawn by the Commission.

54 See paragraph 9.12 and footnote 6 for more information on the Capital Markets Union.

55 Commission Impact Assessment SWD(17) 308, p. 28.

56 The Five Presidents’ Report is available on the European Commission website.

57 See Directive 2014/65/EU, Title V.

58 Regulation 2016/1011. It was cleared from scrutiny and drawn to the attention of the Treasury Committee by the previous Committee on 25 November 2015. The initial proposal was the subject of a House of Commons Reasoned Opinion in November 2013 on the grounds that the draft Regulation introduced an overly prescriptive approach to benchmark regulation which diverged from international benchmark standards.

59 Letter from Harriett Baldwin to Sir William Cash (23 November 2015).

60 These are called “critical benchmarks” in the Regulation; to qualify as “critical”, a benchmark must normally be used as a reference for financial instruments, contracts or fund performance valued in excess of €500 billion.

61 Regulation (EU) 2017/1129. The Regulation was cleared from scrutiny, and drawn to the attention of the Treasury Committee, on 25 January 2017.

62 Directive 2003/71/EC.

63 Including any prospectuses related to asset-backed securities, property companies, mineral companies, scientific research-based companies and shipping companies.

64 See our Report of 22 November 2017 on EuVECA and EuSEF Funds for more information.

65 See the previous Committee’s Report of 11 June 2014 for more information on the ELTIF.

66 In the words of the Commission’s Explanatory Memorandum: “ESMA will ensure that [AIF] managers comply, next to sector specific provisions of the EuVECA or EuSEF Regulations enumerated in their Articles 2(2), with the national law implementing the AIFMD in the Member State of the managers’ establishment”.

67 Moreover, the methodology for the stress tests by all three ESAs will be set by the Executive Boards, rather than by the NCA-dominated Boards of Supervisors, to ensure that the simulations consider the interests of the Single Market as a whole.

68 The internal model quantifies a specific insurer’s prudential requirements on the basis of its liabilities and risk margin.

69 Article 17 of the ESA Regulations.

70 BoS powers have not been delegated to the ESA Chairs, even though this is permitted. Similarly, there have so far been no cases of dispute settlements with binding outcome adopted by the ESAs, and the use of peer reviews has been limited and primarily thematic. There have been no formal recommendations following the identification of a breach of EU law.

71 The UK is represented by the Prudential Regulation Authority within the Bank of England on the Board of Supervisors of the EBA and EIOPA, and by the Financial Conduct Authority on the Board of Supervisors of ESMA. The UK is not currently represented on any of the three Management Boards. The BoS take decisions by simple majority, without weighted votes.

72 The Management Board is composed primarily of the Chairperson, and of representatives of six national authorities elected by the Board of Supervisors for periods of two and a half years at a time. The European Commission, as well as the Vice-Chair and the Executive Director of the relevant Authority, attend Management Board meetings in a non-voting capacity (except on budgetary matters, where the Commission has a vote).

73 For example, where a Supervisory Authority is seeking to declare a breach of EU law by that national authority.

74 All three ESAs have 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.

75 See Commission Impact Assessment SWD(17) 308, p. 96.

76 EBA and EIOPA would have three independent Executive Board members, in addition to the Chairperson. ESMA would have five, to reflect the proposed increase in its direct supervisory responsibilities (see paragraphs 9.38 to 9.56).

77 Commission document COM(17) 331. See our Report of 22 November 2017 for more information on the proposal.

78 .The ESAs get 60 per cent of their budget should 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).

79 In 2016, the total budget for the three Authorities combined amounted to €95.6 million (£84.6 million), of which €52 million (54 per cent) was contributed by NCAs, €33 million (35 per cent) came from the EU budget, and the remainder (€10.5 million or 11 per cent) was collected as fees from the industry by ESMA.

80 Commission Impact Assessment SWD(17) 308, p. 71.

81 The Commission has requested the power to adopt a Delegated Act which will establish how the total amount of annual contributions are calculated and shared among the different categories of financial institutions.

82 See paragraph 9.56 for more information on the proposed new ESMA supervisory powers over Alternative Investment Funds (AIFs).

83 HC Deb 9 October 2017, vol 629, col. 53.

84 Speech by Prime Minister Theresa May (Florence, 22 September 2017).

85 The guidelines on Brexit adopted by the European Council at 27 in April 2017 state that: “Should a time-limited prolongation of Union acquis be considered, this would require existing Union regulatory, budgetary, supervisory, judiciary and enforcement instruments and structures to apply”.

86 In addition to the non-voting members, including the European Commission and the Chairperson of the Authority.

87 During the implementation period the UK’s NCAs would, in the terms of the ESAs’ Founding Regulations, remain the “authorities competent for ensuring compliance” with EU financial services legislation to which the supervisory convergence provisions apply.

88 The ESA Regulations have been incorporated into the EEA Agreement. For Norway, Iceland and Liechtenstein, the EFTA Surveillance Authority carries out the tasks of the ESAs. The EFTA-EEA states NCAs have observer (i.e. non-voting) status on the Boards of Supervisors of the EFTA. If adapted for the UK’s situation, it would have to address the lack of an independent, international authority that could assume the function of the ESAs or the EFTA Surveillance Authority for the UK alone. We therefore think it is most likely the ESAs will retain their powers in relation to the UK as if it were a Member State.

89 See paragraph 9.76 for more information.

90 See paragraph 9.32 for more information on equivalence.

91 Letter from Sir William Cash to Stephen Barclay (22 November 2017).

92 See for example the speech by Michel Barnier at the Centre for European Reform (20 November 2017) or the House of Lords EU Committee Report on Brexit and financial services, paragraphs 89 to 95.

93 Chancellor of the Exchequer Philip Hammond, Mansion House speech, 20 June 2017.

94 As reported by the Financial Times on 1 December 2017, Transport Secretary Chris Grayling “told aviation industry representatives that the government wanted the UK to remain in the European Aviation Safety Agency”.

95 See paragraph 9.56 for more information on the participation of the EFTA-EEA countries in the ESAs.

96 Cabinet Office guidance.

15 December 2017