Tuesday, September 28, 2010

European Parliament Approves Legislation Creating New EU-Wide Financial Regulatory Regime

The European Patliament has approved legislation creating a European financial regulatory framework with separate regulators for securities, banking and insurance, as well as a European Systemic Risk Board similar to the Financial Stability Oversight Council created by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new regulatory framework should be fully operational by January 1, 2011. Praising the new regulatory regime, EU Commissioner for the Internal Market Michel Barnier said that the new regime will give the EU monitoring tools to detect risk which is accumulating across the financial system and provide effective tools to act. The new framework gives the EU the ``control tower and the radar screens’’ needed to identify risks, he said, and the tools to better control financial players, as well as the means to act quickly in a coordinated and timely fashion.

Financial companies and markets operate mostly at a European level, and now the Commission will have four solid authorities to monitor macroeconomic financial risks and supervise financial markets, banks, and insurance companies. These authorities will be able to benefit from the on-the-ground expertise of national regulators and propose any necessary measures at a European level. Commissioner Barnier said that he will soon present legislation to regulate derivatives and short-selling which will build on the powers of the new authorities.

The three new European Supervisory Authorities for securities, banking and insurance are responsible for ensuring that a single set of harmonized regulations are applied by national regulators. The authorities will also ensure a common regulatory culture and consistent practices. They will collect micro-prudential information and ensure a coordinated response in crisis situations. Decisions taken by the ESAs would not impinge in any way on the fiscal responsibilities of the member states. Any binding decision taken by the ESAs would be subject to review by the EU courts.

The new European Securities and Markets Authority will regulate credit rating agencies (CRAs). Since rating services are not linked to a particular territory and the ratings issued by a CRA can be used by financial institutions all around Europe, the Commission has recently proposed a more centralised system for supervision of Credit Rating Agencies at EU level. Under the proposed changes, the European Securities and Markets Authority would be entrusted with exclusive supervision powers over CRAs registered in the EU. It would have powers to request information, to launch investigations, and to perform on-site inspections.

Day-to-day regulation will remain at the national level, close to the ground, where appropriate expertise can be found. There will always be a pivotal role for national regulators like BaFin and the FSA. The new system is a hub and spoke type of network of EU and national bodies. The new authorities will act only where there is clear added value, and the areas where the authorities can act will be strictly defined by Member States and the European Parliament in co-decision. The objective is for European and national bodies to work hand in hand.

The new system has been designed in a way that it can be adapted to future developments in financial services. Every three years the Commission will publish a wide-ranging report on the functioning of the new Authorities and assess whether further steps are needed to ensure the prudential soundness of institutions, the orderly functioning of markets and thereby the protection of investors. This may or may not lead to proposals to change the structures or tasks of the Authorities.

The securities and banking authorities may temporarily prohibit or restrict certain financial activities and toxic securities products that threaten the orderly functioning and integrity of financial markets or the stability of the whole or part of the financial system in Europe in the cases specified in sectoral legislation, such as the proposal on short-selling, or if so required in the case of an emergency.

 It should be clear that we are talking here of emergency powers, which would only apply in exceptional circumstances, defined as a situation which seriously jeopardizes the stability of financial markets. In the great majority of cases, the legislation envisions national and European level authorities to work hand in hand, sharing information, coordinating their work and making decisions together.

Even in emergencies, the first objective of ESMA will be to facilitate and coordinate actions by national securities regulators, without binding decisions. However, if deemed necessary, there is a procedure in place for ESMA and the Board to address binding decisions to national supervisors requiring them to take the necessary action to safeguard the orderly functioning and integrity of financial markets and the stability of the whole or part of the European financial system. So, the new Authorities will have an important co-ordinating role and will be able to adopt decisions requiring regulators to jointly take action. An example of how this power might be used would be to adopt harmonized temporary bans on short selling on EU securities markets, rather than uncoordinated actions in different Member States, as witnessed over the past years.

The new Authorities will also contribute to and participate actively in the development and coordination of effective and consistent recovery and resolution plans similar to Title II of the Dodd-Frank Act, guarantee schemes, procedures in emergency situations and preventative measures to minimize the systemic impact of any failure. The new Authorities should also ensure that they have a specialized and ongoing capacity to respond effectively to the materialization of systemic risks. In doing so, they must identify and measure the systemic risk posed by financial institutions, which must be subject to, inter alia, enhanced regulation.

The Chairpersons of the new Authorities will be appointed by the Boards of the Authorities composed of the Heads of national supervisors, and confirmed by the European Parliament, after a thorough and public selection procedure – based on a short-list prepared by the European Commission. It is envisaged that the Chairpersons will be high-profile individuals with an established reputation in their field.