Brexit: the future of financial regulation and supervision Contents

Chapter 6: Supervisory cooperation

The terrain of supervisory cooperation

161.Supervisory cooperation is an established element within the EU’s supervision of cross-border banking and insurance groups and financial market infrastructures. National Competent Authorities (NCAs) participate in supervisory colleges, reaching joint decisions on prudential requirements to be placed on firms; NCAs also sit on the boards of the ESAs and enter into memoranda of understanding and cooperation agreements with other regulators; and there are day-to-day bilateral relationships between NCA staff at the working level.

162.Sam Woods outlined the forms of supervisory cooperation extant within the EU: “There is a quite highly developed institutional and regulatory architecture around this business of supervisory co-operation, and the best example of that is this thing called the JRAD process, which is the Joint Risk Assessment and Decision.” Mr Woods explained that under the JRAD process, a supervisory ‘college’ is formed, which “comprises the group supervisor of, say, a bank—it is also true for insurance companies—the supervisor of any subsidiary of any size, and the supervisor of any significant branch, but not of other branches”. The college makes decisions on supervisory issues such as capital requirements, which are “taken by the group supervisor and the supervisor of the subsidiaries, but not by the branch supervisor”. Mr Woods therefore concluded: “There is a structure of that kind that we work with today, and that works fine.”292

163.Mr Woods explained that arrangements are different with respect to third countries—in other words, non-EU Member States:

“We have a different model with third countries, and I give the US as an example, where we agree an MoU, and the MoU does two things. One is that it allows the data to flow back and forth, but secondly it has a split of responsibilities: ‘Here is what you are doing, and here is what we are doing’. That is a lighter machinery. With the right level of trust and co-operation on the other side, though, that is also an effective machinery.”293

164.We heard a significant amount of evidence on what Brexit might mean for future cooperation between supervisors and the forms it might take. Several witnesses noted the contribution the UK made at the technical level, and suggested that the UK’s expertise meant that it might maintain some form of influence at the level of supervisory cooperation. For instance, the European Securities and Markets Authority (ESMA) is the ESA responsible for regulating financial markets and enhancing investor protection; KPMG commented that “with its extensive experience in wholesale markets, the FCA has played a central role in the technical rulemaking of ESMA”.294 The influence of the FCA within ESMA was also highlighted by Jonathan Herbst: “There was concern that after the [Brexit] vote the FCA would lose its role on ESMA. That did not happen, and one of the main reasons was that ESMA wanted the technical expertise. Obviously, things will be different after exit, but you can build something.”295

165.Simon Lewis recognised the depth of expertise that the UK has contributed in a supervisory capacity, and suggested that alternatives to ESA board membership may be found, in the form of “some sort of advisory board or some sort of college that can be established so that people of the quality of Andrew Bailey and Sam Woods can continue to contribute to the work of the ESAs”. He argued that there was “wide acceptance in the EU that the UK has played a very important and influential role in the development of the regulatory structure. There is, therefore, an understanding that if we can find a way of accommodating that expertise, that would be good for Europe’s capital markets.”296

166.Professor Niamh Moloney agreed that the ESAs would “have an interest in ensuring that they pull in technical expertise”, but reminded us of “the level at which influence would be exerted”.297 The UK currently contributes at a range of levels within the ESAs, from the board of supervisors to working groups drafting level 2 and 3 technical standards and supervisory guidelines. The question of the level within the ESAs at which influence would be exercised was also addressed by Professor Ferran: “By being involved not just in the board of supervisors but in the more technical committees and working groups below, we can have soft power and influence, but it is a downgrade from where we are.” 298

167.Simon Gleeson told us that supervisors were “absolutely certain that close co-operation is the only way forward and anything less than that will render the entire system significantly less safe”.299 He continued: “It is now absolutely clear that the G6—the globally systemically important banks—are not just the problem of the supervisor in the country where they are incorporated; they are everybody’s problem.”300 Simon Lewis emphasised that “there is a very strong will around joint supervision, and often these joint supervisory roles are based on strong personal relationships. From my perspective, there is a huge amount of personal respect within the EU among the regulatory community.”301 Indeed, as Karel Lannoo noted, supervisory cooperation already exists: “The structures that we have in place today, and had even before the crisis, of supervisory colleges for banks, insurance companies and even infrastructure should continue to be in place.”302

168.The possibility of the UK participating as an observer on ESA boards was mentioned by several witnesses. Dr Kay Swinburne MEP suggested that the EU might consider “opening up these fora to external observers, so that there would at least be a confidential dialogue amongst regulators about the direction of travel and perhaps a greater, more detailed dialogue about technical aspects of regulation”.303 However, the limitations of observer status were also recognised. Professor Niamh Moloney cautioned that “you are in the room at the highest level; by the time something has got to the board of supervisors it is very much at the level of contestation on big principled points”.304 Dr Swinburne discussed observer status in the context of the ECON Committee: “People can sit and observe, but they obviously do not contribute in any meaningful way.”305 Professor Eilís Ferran noted that there were conditions associated with observer status: “There are arrangements regarding staff and financial contribution and for the adoption or following of EU law; and you do not get a vote.”306

The review of the ESAs

169.In our Call for Evidence (see Appendix 3), we asked about the review of the ESAs that the Commission was conducting at that time, including the key areas in which reform should be pursued, and what the potential impact of such changes would be on the UK. On 20 September 2017 the European Commission published an omnibus package of legislative proposals following on from the ESA review.307 The package proposes alterations to the powers, funding and governance of the ESAs. The fundamental aim is to promote supervisory convergence: this is in part achieved by transferring supervisory powers from NCAs to the EU and enhancing cooperation.

170.Witnesses considered how desirable such centralisation of powers would be and how it might affect UK and EU domestic authorities. Both AFME and Clifford Chance were in favour of the ESAs playing more of a role in equivalence determinations, as a means of depoliticising the process. AFME stated that the ESAs “could strengthen their valuable role in providing more resource and technical advice in the context of equivalence assessments and ongoing monitoring of equivalence”. They could, for example, be tasked with monitoring “the regulatory, supervisory and market developments in third countries while leaving the ultimate decision on the third country equivalence status with the European Commission”.308

171.Clifford Chance agreed, adding that “it is advantageous for the UK authorities to be able to deal with a single EU voice rather than a plethora of national voices”.309 While this already appeared to be the case within the banking industry, the position for insurance and securities regulation left UK firms with a “‘who do I speak to when I want to speak to Europe’ problem. Consequently the UK should encourage the EU to unify its securities and insurance regulatory policymaking at an EU level to the greatest degree permissible under the existing EU treaties.”310 Simon Gleeson endorsed the policy aims of the omnibus package, connecting it with the EMIR review: “It is unquestionably right that the ultimate aim of European policy-making is a single securities regulator.”311 He also sought coordinated engagement with Europe, and believed that there would be further transfers of power, “with the aim of trying to turn ESMA into a single European securities supervisor”:

“It seems to me to be a very good thing for the UK, and I wish it was happening faster. If our securities regulator had a single European securities regulator to talk to, the dialogue would be much more efficient than where we will end up if the securities regulator in the UK has to maintain dialogue with 27 different securities regulators, ESMA and the Commission. At the moment, the fragmented nature of supervision in Europe in that direction is an obstacle to the development of sensible relationships between the UK and the EU.”312

172.Jonathan Herbst, in contrast, questioned the value of any centralisation of power within ESMA: “It will depend on how ESMA uses its powers. If it is, essentially, to lock out the UK, a degree of member state discretion could be very beneficial. We are already seeing examples of that, with different member states taking slightly different approaches. I am not entirely convinced that the federal solution is good for us.”313

173.In contrast, John McFarlane was sanguine about centralisation of supervisory powers within the EU more generally: “While it is theoretically a concern, personally, I am not ultra-concerned about it. We have US dollars overseen by the Fed. We are quite used to that. We are quite used to euro activities being overseen by the ECB and others. That will continue post Brexit. I cannot imagine that it will change.” Given that other European regulators “are all part of the Financial Stability Board and that global standards are likely to apply, and given that national standards in the EU will not necessarily apply to cross-border activity, I think this will all sort itself out”.314

The challenges and opportunities of joint supervision: CCPs

174.Regardless of whether or not there is an agreement on market access, the need for supervisory cooperation will remain. Issues of joint supervision are especially important to the clearing industry. The European Market Infrastructure Regulation (EMIR), which was adopted in 2012 in the wake of G20 commitments, requires that most OTC (over-the-counter) derivative contracts be cleared via clearing houses (known as central counterparties, or CCPs). EMIR mandates CCPs to be authorised by a cross-border college of supervisors in order to offer clearing services in the EU; once authorised, EU firms can use the CCP in order to fulfil their clearing obligations under EMIR. ESMA participates in the colleges that govern the registration and supervision of CCPs, and UK CCPs are authorised jointly by the Bank of England and ESMA. The FCA also currently works closely with ESMA. Measures adopted to supervise clearing houses may therefore serve as a model for potential supervisory cooperation in other fields.

175.Dr Kay Swinburne MEP has been closely involved in the development of the EU’s regime on clearing, and told us about the progress that had been achieved: “The EMIR legislation has become the gold standard throughout the rest of the world.” She explained that EMIR instituted a variety of risk management strategies:

“Rules were put in for a very extensive default waterfall, where everyone knew up front what they were committing themselves to in risk management, what tools were allowed to be used by the CCP on their behalf and how the risk would be mutualised through the system, depending on what had happened.”315

She then referenced a proposal currently under consideration,316 on which she is the co-rapporteur:

“The final piece of that jigsaw is recovery and resolution, which is what happens when you get to the end of the default waterfall and you need to find additional tools either to resolve or to continue the business, if it is a critical function, for market stability.”317

176.The Commission is also currently consulting on proposals to amend EMIR itself.318 The proposals as they stand—which are under discussion in the Council—would entail greater EU oversight and potentially the compulsory relocation of third-country CCPs to the EU. Under the Commission’s draft text, the legislation would create a category of third-country systemic CCPs subject to the possibility of de-authorisation where joint supervision is judged by the EU not to adequately contain risk. The ECB has likewise requested greater authority over clearing systems, via an amendment to Article 22 of its statute, currently pending approval by the Council and European Parliament.319

177.Witnesses described the EMIR proposals as the source of greater concentration of power within the ESAs, especially ESMA. Simon Puleston Jones of the FIA summarised the proposals thus: “What we are seeing through the EMIR agreement is a greater centralisation of powers in ESMA when it comes to the supervision of European clearing houses. To the question, ‘From outside Europe, to whom do I pick up the phone if I want to speak to Europe?’, the answer is ESMA.” He explained that “ESMA would have a greater ability to access information related to third-country clearing houses, as well as the right to visit locally on the ground to check compliance”.320 ESMA would in consequence have a greater degree of control over third-country CCPs than is the case today.

178.Simon Lewis was positive about the changes, describing them as a “very sensible step forward”. He was of the view that, given the importance of CCPs, “to have an additional level of supervision—so in addition to the NCA, to have ESMA providing supervisory oversight—we think is a good development … it is a rather good example, if I may say so, of joint supervision. The combination of a pan-European supervisor with the local NCA should reassure people that CCPs will be supervised more effectively.” He cautioned, however, that “the devil as always will be in the detail”.321

179.Daniel Maguire, of the London Clearing House, also recognised the desire of the Commission to centralise the supervision and regulation of CCPs, acknowledging that “ESMA is well placed to do that”. However, he wished “to ensure that all the jurisdictions we are regulated by and all the authorities or supervisory bodies overseeing this have the right skill set, competencies and so on”.322 He believed that ESMA might need to develop its resources in future.

180.Mr Maguire was also concerned about the location policy, noting that it was not automatic that, if relocation were enforced, it would benefit the EU: “When you start to consider that location, the answer is not necessarily relocation to Europe; the answer may be relocation going the other way—to the States. This is an internationally integrated market and, if things did need to move, it is not a fait accompli that business would move to Europe.”323

181.The City Minister, Stephen Barclay MP, also focused on the disadvantages of relocation:

“If one was pursuing a policy in Europe of domiciling euro clearing back to Europe, the consequence would be less diverse and less liquid, with more market fragmentation, higher cost and more financial instability … I do not think that is in the interests of the Europeans, nor is it in the interests of the UK.”324

182.Mr Maguire added that relocation would compromise some of the risk mitigation features of central clearing, in particular the netting of different exposures:

“The whole concept of a clearing house in multi-currency derivatives comes back to the points we were discussing earlier around having everything as much as possible in one place. The idea of splitting pieces up is not in the interest of many … once you get into the detail of globally integrated markets, this is not a zero-sum game. This is a situation where, if you split the liquidity out, both sides will lose.”325

183.On alternatives to relocation, Mr Puleston Jones foresaw “a world where the most proportionate outcome in order to manage [concerns about euro clearing occurring offshore in a crisis] is to have an enhanced co-operation arrangement between the European and UK regulatory authorities”. He explained that there was “already a model for that between the CFTC in the US and the Bank of England”. Such an agreement, in which it is determined “at the outset, if a UK clearing house or a US clearing house were to default, what those clearing houses would do”, would, he felt, address concerns about oversight during a crisis. He highlighted a number of pertinent questions:

“What would the supervisory authorities do? Who would be in control of making what decisions? Who has the final say? To what extent might Europe and European authorities, including the central banks, be involved in the decision-making process, whether that be in the default of the CCP or, absent the default of a CCP, another euro crisis, as we had at the beginning of this decade?”326

184.Sir Jon Cunliffe took a similar view:

“What I see in the European proposals, which have a number of different models and a tiering of different sorts of CCPs, is recognition of this need to reflect the multilateral nature of CCPs, and recognition that you need to defer to the home supervisor but there have to be some arrangements between them. Even if we were not going through Brexit, we would have to develop the way we supervise and regulate these critical pieces of international infrastructure, simply because of this co-ordination issue.”327

185.Dr Kay Swinburne MEP also emphasised the degree of cooperation that is already in place for CCPs: “We have got to the stage where co-operation between regulators for CCPs is extensive and frequent.” This was particularly the case with respect to the information exchange that underpinned cooperation, which “now happens not just regularly but daily … It is also very detailed, in a way that never happened before, so I am convinced that the risk management procedures within the globally systemic CCPs, of which there are very few, are much stronger than they ever were.”328

Conclusions and recommendations

186.The Commission’s proposed revisions to EMIR contain both good and bad elements. Giving ESMA additional powers of oversight will help reassure financial market participants, especially to the extent that this will involve cooperation with the NCAs. However, proposals to demand the relocation of systemic CCPs within the eurozone will not achieve the Commission’s objectives of bolstering financial stability. They will instead increase costs to market participants, particularly those inside the EU-27; cause fragmentation, by reversing G20 measures taken to contain risk within CCPs; and result in the loss of clearing business for both the UK and EU-27, as clearing members move their positions to New York. The Government should resist these measures by whatever means possible.

187.The existence of supervisory colleges, and the relationships between third-country NCAs and ESMA, could serve as a template for future supervision of financial market infrastructures. To the extent that such supervisory cooperation promotes financial stability, as would be the case with the proposals to revise EMIR, it may also obviate the need to relocate those infrastructures within the EU. Further measures to enhance such cooperation within the European legislative structure should therefore be encouraged, although proposals to centralise authority in ESMA will need to be carefully scrutinised.

188.The evidence we heard consistently highlighted the strength and depth of existing supervisory cooperation and the extent of the EU’s reliance on the UK’s contribution. While the UK’s technical expertise is an asset for the EU, the Government should not treat this as a guarantee that the UK will be able to continue to contribute to the decision-making process. We therefore urge the Government to seek to secure continued participation for UK regulators at all levels of the supervisory architecture post-Brexit, to be imaginative in developing new forms of cooperation, and to continue to invest in international and bilateral relationships.


294 Written evidence from KPMG (FRS0043)

307 Proposal for a Regulation of the European Parliament and of the Council 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, COM(2017) 536 final

308 Written evidence from AFME (FRS0021)

309 Written evidence from Clifford Chance (FRS0039)

310 Written evidence from Clifford Chance (FRS0039)

316 Proposal for a Regulation of the European Parliament and of the Council on a framework for the recovery and resolution of central counterparties and amending Regulations (EU) No 1095/2010, (EU) No 648/2012, and (EU) 2015/2365, COM (2016) 0856 final

318 Proposal for a Regulation of the European Parliament and of the Council 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, COM (2017) 0331 final

319 Commission opinion of 3 October 2017 on the Recommendation of the European Central Bank for a Decision of the European Parliament and of the Council amending Article 22 of the Statute of the European System of Central Banks and of the European Central Bank, C(2017) 6810 final




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