7European System of Financial Supervision
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Committee’s assessment |
Politically important |
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(a), (b) and (d) Not cleared from scrutiny; drawn to the attention of the Treasury Committee; (c) Cleared from scrutiny |
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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 and Directive 2009/138/EC on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II); (c) Proposal for a Regulation on the European Systemic Risk Board; (d) Amendment of pending proposal for a Regulation as regards the procedures and authorities involved for the authorisation of CCPs and requirements for the recognition of third-country CCPs |
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Legal base |
(a)—(d): Article 114 TFEU, ordinary legislative procedure; QMV |
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Department |
Treasury |
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Document Numbers |
(a) (39052), 12420/17 + ADDs 1–2, COM(17) 536; (b) (39053), 12422/17, COM(17) 537; (c) (39055), 12430/17 + ADD 1, COM(17) 538; (d) (39056), 12431/17, COM(17) 539 |
Summary and Committee’s conclusions
7.1The European Commission in September 2017 proposed substantial reforms for the functioning of the EU’s financial supervisory authorities (the ESAs) for the banking, insurance and investment industries, as well as proposing changes to the European Systemic Risk Board (ESRB), which monitors the build-up of macroprudential risks in the EU’s economy.
7.2As 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. The European Commission has made clear that its proposals are driven, in part, by the UK’s withdrawal from the EU. This has led to a perceived need to strengthen the ESAs to enable them to tackle any UK financial services firms which 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.
7.3When we first considered the proposals in December 2017, we expressed our concern about the proposal to allow the ESAs to set supervisory priorities for domestic regulators; the increased direct supervisory responsibilities of ESMA for certain financial products; 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). We asked the Minister for further information about the Government’s position on the proposed changes to the ESAs and the ESRB, and retained both documents under scrutiny in the meantime.
7.4The new Economic Secretary to the Treasury (John Glen) wrote to us on 31 January 2018 with further information on the Government’s position on both sets of proposals. With respect to the proposed changes to the European Systemic Risk Board, which are uncontroversial and technical in nature, he explained that the Government is broadly supportive of the suggested reforms. The Minister also reiterated the ambition to establish a post-Brexit partnership on financial services that includes “regulatory and supervisory cooperation”, and the aim of continued cooperation between the ESRB and the Bank of England.
7.5However, the Minister’s letter on the European Supervisory Authorities made clear the Government’s opposition to many elements of the Commission proposals affecting their powers and governance.109 He expresses particular concern about the increased direct supervisory responsibilities of ESMA for various investment products and services, and the proposed ability for the ESAs to set supervisory priorities for national regulators. We have set out the substance of the Government’s position in more detail in paragraph 6.23 below.110
7.6The Economic Secretary also sought to reassure us about the implications of Brexit for the UK financial services industry becoming a “third country” vis-à-vis the Single Market. In particular, he writes that the representation of the Bank of England and the Financial Conduct Authority within the ESAs during the transition remains a matter for negotiation. He also reiterates that the EU’s third country “equivalence regime” for cross-border access for non-EU financial services providers to EU-based clients may not necessarily apply to the UK firms after Brexit, as the Government is seeking to negotiate a bespoke UK-EU regulatory arrangement under which there would be a “new process for conducting cross-border business”.
7.7We thank the Minister for the additional information he has provided on the Government’s approach to the ESFS proposals. It is clear that it does not support many parts of the ESA reform package, and we will closely follow the negotiations on the relevant legislative proposals within the Council and the European Parliament in the coming months. We note that the Bulgarian Presidency has provisionally scheduled a debate on the ESFS package at the meeting of EU Finance Ministers on 22 June 2018. We ask the Minister to write to us after that meeting with further information on the state of play (or earlier, in the unlikely event that negotiations within the Council working party proceed at a faster pace).111
7.8We remain concerned about the UK’s representation within the ESAs and the ESRB under the post-Brexit transitional arrangement. The EU has repeatedly stated that the Government and its regulators will no longer be represented within the governance structures of any EU bodies or agencies during this period, although EU financial services legislation and the ESAs’ powers would continue to apply in the UK.112 The European Commission has explicitly said that the UK could “attend meetings of [the] ESAs only exceptionally and on a case-by-case basis”.113 The Minister has not been able to offer any reassurance in this regard, saying only that the issue of representation is subject to negotiations with the EU. We ask him to write to us again when the negotiations on the transitional period are concluded, with his assessment of the implications for the ability of the UK’s NCAs to be represented within the ESAs during this period.
7.9With respect to the future UK-EU relationship after the transition, we remain supportive of the Government’s intention to negotiate “a new process for conducting cross-border business” which would go “beyond the third country equivalence regimes in the EU acquis” to take effect after the transitional arrangement ends.
7.10However, we remain unsatisfied with the Government’s refusal to provide any concrete detail of its proposals in this regard, particularly with respect to the “process for establishing regulatory requirements for cross-border business between the UK and EU”, to which the Chancellor referred in his 2017 Mansion House speech.114 The EU would make any preferential cross-border access to its market for financial services depend, primarily, on continued alignment of UK and EU financial services regulation.115 We will therefore pay particular attention to the balance the Government seeks to strike between UK’s post-Brexit regulatory autonomy and any overarching legal obligations vis-à-vis the EU to secure preferential access to the Single Market for financial services.
7.11In view of our concerns, we retain the ESA proposals under scrutiny and draw the Minister’s letters to the attention of the Treasury Committee. We are content to now clear the ESRB Regulation from scrutiny, given the nature of the changes proposed.
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 ADDs 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) Proposal for a Regulation amending Regulation (EU) No 1092/2010 on European Union macro-prudential oversight of the financial system and establishing a European Systemic Risk Board: (39055), 12430/17 + ADD 1, COM(17) 538; (d) 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 (EMIR II Commission’s proposal): (39056), 12431/17, COM(17) 539.
Background
7.12The 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), built on a two-pillar system of macro-prudential and micro-prudential supervision. Such supervision is conducted at EU-level by the European Systemic Risk Board (ESRB) and the European Supervisory Authorities (ESAs) respectively, and at Member State level by the relevant domestic financial authorities.
7.13The ESAs draft tertiary EU legislation to give effect to the Directives and Regulations that govern financial services within the Union, and also have powers to foster regulatory and supervisory convergence through dispute settlement powers in cases of disputes between NCAs and by investigating potential breaches of EU law by domestic regulators.116 Thee decision-making powers of the ESAs rests with their respective Board of Supervisors (BoS), on which only the Member States’ national competent authorities—including for the UK the Bank of England, the Prudential Regulation Authority and the Financial Conduct Authority—have a vote.
7.14In parallel, the European Systemic Risk Board (ESRB) is responsible for macro-prudential oversight of the financial system in the EU. Its primary task is to monitor and assess the build-up of risks in the financial system and issue warnings and recommendations accordingly.
The ESFS package
7.15In September 2017 the European Commission proposed substantial reforms of the functioning of the ESAs and the ESRB. As set out in more detail in our Report of December 2017,117 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.
7.16The Commission also proposed some technical changes to the composition and functioning of the ESRB to reflect the creation of a new Single Supervisory Mechanism within the European Central Bank and a Single Resolution Fund for the Eurozone. Primarily, this means that the President of the European Central Bank will be the ex officio Chairman of the European Systemic Risk Board, and representatives of the Single Supervisory and Resolution Mechanisms will become voting members of the Board.
7.17It is clear from the Commission’s explanatory notes that the proposals to reform the European Supervisory Authorities are driven, at least in part, by the UK’s withdrawal from the EU. 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.
7.18The then-Economic Secretary to the Treasury (Stephen Barclay) submitted an Explanatory Memorandum on the proposals in October 2017.118 This did 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.
7.19The Committee concluded that the proposed legislation was of major political importance, as 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. There would also be a financial impact on the UK sector, as the Commission proposes to replace the current part-funding of the ESAs’ by contributions from national regulators by an industry levy.
7.20The package also had a specific impact on the UK in the context of Brexit, which is likely to lead to its designation as a “third country” for the purposes of the provision of financial services into the EU (unless a more comprehensive financial services agreement is negotiated).
7.21As described in our previous Report, we are most concerned about:
- allowing the ESAs to become more independent from national regulators through the creation of new “Executive Boards”;
- setting EU-wide supervisory priorities for domestic financial regulators through Strategic Supervisory Plans;
- the financial implications for the UK sector of the new industry levy to fund the ESAs’ operations;
- increasing the responsibilities of ESMA, in particular the expansion of its direct supervisory powers to certain alternative investment funds;
- the EU’s stipulation that the UK will have no representation on the governance structures of the ESAs during the post-Brexit “implementation period”,119 while the ESAs would retain their powers in relation to the UK’s financial regulators and industry during this period; and
- the implications of new powers for the ESAs in relation to certain financial products—including prospectuses and benchmarks—offered by non-EU firms to EU-based customers (which will become relevant once the UK becomes a “third country” vis-à-vis the Single Market).
7.22We asked the Minister to provide further information on the Government’s position on the proposals in light of these concerns.
The Minister’s letter of 31 January 2018
7.23The new Economic Secretary (John Glen) provided further information on the Government’s position on the elements of concern within the ESFS proposals at the end of January.120
The substance of the Commission proposals
7.24In summary, with respect to the new powers and governance structures for the ESAs, the Government is of the view that:
- there is no need for Strategic Supervisory Plans at EU-level which constrain national financial regulators, as these would interfere with domestic priorities and dilute accountability to national parliaments;
- representatives of the national competent authorities (such as the Bank of England) should remain on the ESAs’ new Executive Boards if they can act autonomously;
- the potential for the ESAs to restrict delegation of portfolio management or risk transfer to non-EU countries “conflicts with the principle of subsidiarity and with a business model that is designed to support open, global capital markets”, and could risk “significant disruption to delegation from fund domicile jurisdictions to third countries”;
- there is no justification for the centralisation of direct supervisory powers for certain financial benchmarks and investment prospectuses in ESMA, as such responsibilities can be discharged more efficiently at national level; and
- further information is needed from the Commission on the proposed industry levy, including with respect to the calculation of firms’ contributions and to which firms the levy would apply.
The implications of Brexit
7.25With respect to the implications of the ESFS proposals for the UK once it ceases to be a Member State, the Minister says:
- the UK’s representation on the governance structures of the ESAs’ during the post-Brexit transitional period, when EU financial services legislation would continue to apply in the UK, is subject to discussion with the EU and the Minister will inform the Committee “as negotiations progress”; and
- following the transitional period, UK firms may not be considered “third country” undertakings for the purposes of accessing the Single Market, because the conditions for cross-border access using the EU’s existing equivalence regimes—“would not support the scale and complexity of trade in financial services that exists between the UK and the EU”. The Minister reiterates the Government’s intention to negotiate “a new process for conducting cross-border business” which would go “beyond the third country equivalence regimes in the EU acquis”.121
Previous Committee Reports
For the ESA proposals, see (39052), 12420/17 + ADD 1–2, COM(17) 536: Fifth Report HC 301–v (2017–19), chapter 9 (13 December 2017). For the ESRB proposal, see (39055), 12430/17 + ADD 1, COM(17) 538: Fifth Report HC 301–v (2017–19), chapter 11 (13 December 2017).
111 The European Parliament’s Economic & Monetary Affairs Committee has provisionally scheduled a vote on the proposals for September 2018. It therefore appears unlikely that trilogue negotiations on the final legislative texts will be concluded before the end of the year at the earliest.
112 European Council guidelines of 15 December 2017: “The European Council notes the proposal put forward by the United Kingdom for a transition period of around two years, and agrees to negotiate a transition period covering the whole of the EU acquis, while the United Kingdom, as a third country, will no longer participate in or nominate or elect members of the EU institutions, nor participate in the decision-making of the Union bodies, offices and agencies”.
113 European Commission presentation on Brexit and services, p. 51 (accessed 6 February 2018).
114 https://www.gov.uk/government/speeches/mansion-house-2017-speech-by-the-chancellor-of-the-exchequer.
115 For example, the European Commission has reiterated that “free trade agreements offer very limited market access mostly via establishment but not comparable to the Single Market” because they “do not ensure convergence of regulatory frameworks”.
116 Under the “breach of Union law” procedure, the ESAs can 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
117 See Report of 13 December 2017.
118 Explanatory Memorandum submitted by HM Treasury (16 October 2017).
119 European Council guidelines on Article 50 of 15 December 2017: “The United Kingdom, as a third country, will no longer participate in or nominate or elect members of the EU institutions, nor participate in the decision-making of the Union bodies, offices and agencies”.
121 The Committee is awaiting a reply from the Minister to an earlier letter requesting further information on the Government’s concrete proposals for these new regulatory decision-making processes; whether they would produce legal effects in the UK and the EU; and how they would facilitate cross-border flows of financial services.
23 February 2018