The most effective and efficient way to achieve the global harmonization of financial and derivatives regulation is through a system based on equivalence and mutual recognition, said Verena Ross, Executive Director of the European Securities and Markets Authority (ESMA). In remarks at the International Council of Securities Associations, she emphasized that cross-border coordination of regulation is very important given the interconnectedness of the financial markets and the need to avoid regulatory arbitrage.
Without mutual recognition, reasoned the ESMA official, entities operating on a cross-border basis would be subject to different requirements and to the jurisdiction of different authorities, which exposes them to potentially conflicting requirements and to higher compliance costs. However, the robustness of a foreign regulatory system must be assessed before it can be relied upon. Thus, equivalence needs to be assessed of the home country’s regulation of the foreign market player. When the home country regulation achieves similar outcomes, one needs to rely on mutual recognition and co-operation with the home country regulator. This cooperation with the home country regulator is essential to ensure that when needed and in response to specific risks the third-country market participant can be supervised in the same way as domestic market participants.
A specific example of where ESMA has applied this model of mutual recognition concerns the endorsement assessment of third countries for credit rating agencies. The essence of the assessment is whether ratings from third countries used in the EU meet EU requirements. While the banking industry in particular was understandably concerned about sufficient third countries being endorsed before the deadline, the senior official noted, it can now be seen that the most important third countries have been endorsed.
Looking back at the whole assessment process, the ESMA Executive Director was quite positive about the current third-country regime for credit rating agencies. It ensures a level playing field between the EU and other regions, she enthused, and investors can expect the same quality of endorsed non-EU ratings as EU-rating.
When regulating national or, in the case of the EU, regional financial markets, the issue
needs to be addressed of how international market players are regulated. For example, there is the issue of how to regulate market players like credit rating agencies, hedge funds, private equity firms, and central counterparties from third countries outside the EU that are doing business in the EU. To provide EU investors with the same level of protection, and to create a level playing field with EU market players, these third-country market players need to meet the same EU requirements, noted the ESMA official, which raises the potential problem of market players becoming subject to multiple regulatory regimes.
These potential problems can be controlled under two conditions. The first one is that the regulatory requirements of the third country and the EU are broadly similar. More common regulations between home and host countries obviously limit the potential problems facing cross-border entities and activities. Second, authorities must avoid circumstances where market players are subject to two, or even more, sets of daily regulatory demands.
Currently, while there is a G-20 commitment to harmonized financial regulation and a role for the Financial Stability Board, noted the official, there is no global governance mechanism which ensures that governments take coordinated decisions regarding the regulation of financial markets. The EU has developed such a mechanism after many decades: the European Commission, Council, and EU Parliament can decide on Directives and Regulations, and ESMA now has the powers to write technical standards. ‘
While sovereign governments can obviously deviate locally, she observed, such deviations come at a high price. Not achieving broadly common financial regulation will inevitably lead to different levels of investor protection, as well as an uneven playing field and the potential to spread risks, along with the overall specter of regulatory arbitrage.
Not to minimize the G-20’s actions, the ESMA official pointed out that as a result of these G-20 commitments the regulatory developments in the main global financial centers are broadly similar on such issues as credit rating agencies, hedge funds
and OTC derivatives. ESMA supports a strong international community of securities regulators driving the international policy debate on financial market regulation. This is needed so regulators can ``be ahead of the curve” and identify future areas of regulation and offer possible regulatory frameworks. For example, an area where this has worked well is credit rating agencies where IOSCO published its first principles in 2003. The actual IOSCO Code of Conduct Fundamentals for Credit Rating Agencies has been largely incorporated in legislation in many countries in response to the financial crisis.
In addition, the initiatives related to OTC derivatives are a good example of the need for global convergence and cooperation. In
the result from the G-20 commitments has been EMIR, and to a degree the provisions on derivatives
transparency in MiFID II. But the same
issues are occupying ESMA’s counterparts in the US,
Asia and other parts of the world. Regulators
have also set up a number of international groups aiming at achieving international consistency of the different
regimes, and ESMA plays a full role in this global dialogue.