Select Committee on European Union First Report



EU legislative initiatives in response to the financial turmoil

Background

1.  On 25 November 2008, Lord Turner of Ecchinswell, Chairman of the Financial Services Authority (FSA), gave evidence to Sub-Committee A (Economic and Financial Affairs and International Trade) of this Committee about the European Commission's regulatory proposals and changes to supervisory structures in response to recent events in the finance industry. Lord Myners, Financial Services Secretary to the Treasury, provided information on the Government's view on these legislative proposals and their progress towards agreement at the Council of Ministers. This report aims to summarise these initial Commission proposals and makes available for the information of the House the current view of the Government and the FSA.

2.  At the time of preparing this report, we had scrutinised proposed amendments to the Capital Requirements Directive[1] (CRD) and the Directive on deposit guarantee schemes[2] and cleared them from scrutiny. A general approach to these documents was agreed by the Council of Ministers on 2 December 2008 and the proposals are now subject to the agreement of the European Parliament. The Commission had recently published its proposed reforms of the rules regarding credit ratings agencies.[3]

3.  We are now launching an in-depth inquiry on EU responses to these events. This will focus upon four key issues: Commission legislation to implement a prudential European financial regime; the future role of a European supervisory system; the effectiveness of European institutions in responding to the turmoil; and the role of the EU in the global response to events. A Call for Evidence is printed in Appendix 2. Sub-Committee A will take both written and oral evidence for this inquiry in the New Year.

Reform of Supervisory Frameworks

4.  Reform of supervisory frameworks, at both a European and a global level, has been a key issue in the wake of the recent events. Greater cooperation of supervisors has been at the forefront of EU initiatives, particularly the suggestion of a group of supervisors, formalising the framework governing cross-border supervision of financial institutions.

5.  No initiatives have yet been proposed with the sole purpose of reform of supervisory frameworks. However, both the CRD and Solvency II[4] (which reforms the regulatory and supervisory structures of EU insurance firms) tackle this issue. The Committee has previously examined the Solvency II proposals in its 6th Report of Session 2007-2008.[5] The attitude of the Government differs in their approach toward these two proposals. The original Solvency II proposals, which were strongly supported by the Government, would have installed a system of centralised group supervision for cross-border insurance companies.[6] In recent negotiations on the CRD however the Government have argued for the final decision on suitable capital adequacy levels of financial institutions to lie with local supervisors, maintaining the FSA as ultimately responsible for the capital adequacy of UK institutions.

6.  We ask the Government, in their response to this report, to clarify their policy on the design and powers of colleges of supervisors for companies that operate subsidiaries or branches in other territories since they appear to take different approaches under Solvency II and the CRD. The Government should also clarify whether they adopt the same approach for colleges involving regulators from outside the EU as they do for those consisting solely of EU-based regulators.

The Capital Requirements Directive

7.  The CRD (Directives 2006/48/EC[7] and 2006/49/EC[8]) regulates the capital held by financial institutions within the EU, reflecting international standards agreed at the Basel Committee in 2004. The proposed amendments modify the existing Directives in four key areas:

  •   Large Exposures Regime—The maximum exposure limit of a bank to any one client will be 25% of a bank's own funds, regardless of the length of the exposure;
  •   Hybrid Capital Instruments[9]—A quantitative limit is to be applied to the level of Hybrid Capital Instruments that can qualify as own funds. An EU wide criterion for higher quality own funds is also to be implemented;
  •   Supervisory Arrangements—Multilateral exchange of information between national supervisors is to be facilitated, including a mediation mechanism to be used when agreement between supervisors cannot be reached; and
  •   Securitisation—A quantitative minimum retention requirement of 5% of the total material share of the risk is to be retained by the originator. Disclosure and transparency requirements are also proposed.

Deposit Guarantee Schemes

8.  The amendments to Directive 1994/19/EC[10] covering deposit guarantee schemes propose the following changes:

  •   Raise the minimum guarantee level to €50,000 upon implementation, rising to €100,000 within a year;
  •   Reduce payout delay from three months to three days; and
  •   Eligible deposits will become 100% recoverable.

Rules on Credit Ratings Agencies

9.  Credit ratings agencies rate the risk of debt issuances. The failure of the credit ratings systems, and the lack of supervision thereof, have been seen as major causes of the recent financial volatility. COM (2008) 704 sets out the following rules for these agencies:

The Chairman of the FSA's Evidence

10.  The following issues were explored at our oral evidence session (a full transcript is printed on pages 1-10) with Lord Turner of Ecchinswell:

Ministerial Correspondence

11.  Our correspondence with Lord Myners (printed in Appendix 3), Financial Services Secretary to the Treasury, discussed the following issues:



1  
COM (2008) 602/3 http://ec.europa.eu/internal_market/bank/docs/regcapital/crd_proposal_en.pdf Back

2   COM (2008) 661 http://ec.europa.eu/internal_market/bank/docs/guarantee/dgs_proposal_en.pdf Back

3   COM (2008) 704 http://ec.europa.eu/internal_market/securities/docs/agencies/proposal_en.pdf Back

4   COM (2008) 119 http://ec.europa.eu/internal_market/insurance/docs/solvency/proposal_en.pdf Back

5   European Union Committee, 6th Report (2007-2008): Solvency II (HL 42) Back

6   This issue was discussed at the ECOFIN Council of 2 December. The French Presidency suggested a compromise text removing the proposals for group supervision. Whilst this satisfied smaller Member States which were concerned that group support would remove control from local supervisors, the UK Government strongly objected to the amendment. A general approach in accordance with the French proposal was agreed at the Council and the European Parliament is expected to vote on the revised proposal on 15 December. Back

7   http://eur-lex.europa.eu/LexUriServ/site/en/oj/2006/l_177/l_17720060630en00010200.pdf Back

8   http://eur-lex.europa.eu/LexUriServ/site/en/oj/2006/l_177/l_17720060630en02010255.pdf Back

9   Capital structured as debt that has equity-like features. Back

10   http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:31994L0019:EN:HTML Back


 
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