Yesterday, the European Commission voted to approve the financial supervision reform package, which will shift the manner in which banks, stock markets and insurance companies are supervised and policed in Europe. The President of the European Commission, José Manuel Barroso stated that the “banking crisis exposed the gaps in the financial services supervision in Europe,” where the European market “was interdependent but oversight was purely national.” He noted that the new financial reform package resulting from the European Commission’s proposals will become effective in January 2011.

Pursuant to the financial supervision reform package, the three financial services committees which currently exist at the EU level will be replaced by a new European Systemic Risk Board (ESRB) and three new European Supervisory Authorities (ESAs) for the financial services sector: the European Banking Authority (EBA) based in London, a European Insurance and Occupational Pensions Authority (EIOPA) in Frankfurt and a European Securities and Market Authority (ESMA) in Paris. The ESRB, which will be presided over by the President of the European Central Bank for the first five years, will monitor and assess potential threats to financial stability arising from macroeconomic developments and will issue recommendations for action to deal with systemic risk. Specifically, the ESRB will establish a common set of indicators to develop uniform ratings of the riskiness of specific cross-border financial institutions. The ESAs will consist of the 27 national supervisors, and will work in jointly with the existing national supervisory authorities to safeguard financial soundness at a microeconomic level by supervising individual financial firms and protecting consumers of financial services.

Generally, the ESAS will be entrusted with tough new powers, including the following:

  • Proposing specific rules for national authorities and financial institutions, including developing technical standards, guidelines and recommendations, and monitoring how these rules are being enforced by national supervisory authorities;
  • Acting in emergencies, including banning certain financial activities and products;
  • Mediating and settling disputes between national supervisors; and
  • Ensuring consistent application of EU law.

Additionally, the ESMA will be given direct supervisory powers over credit rating agencies registered in the EU, which include powers to request information, launch investigations and perform on-site inspections. However, the regulations establishing the new authorities expressly prohibit them from taking any actions which would impinge on the fiscal responsibilities of any Member State, and therefore the new authorities would not be permitted to order a Member State to bail out a financial institution.

The new EU financial supervision system has been designed in a manner to allow adaptation to future developments in the financial services sector. To that end, the European Commission is required to publish a report every three years discussing the functioning of the newly-established authorities and whether supervision of banking, securities and insurance should be combined. Furthermore, the European Commission must determine whether additional steps are necessary to ensure the prudential soundness of financial institutions, the orderly functioning of markets and the protection of depositors, insurance policyholders and investors. The European Commission intends to propose and adopt wider financial services reform by the end of 2011, and allow for national implementation by the end of 2012.