On 27 May 2009 the European Commission published a Communication outlining proposals for a new approach to the supervision of the financial markets in Europe. The reforms outlined in this Communication are intended to address the failings in financial regulation that have been exposed by the current banking crisis.

There are currently three financial services committees involved in financial supervision at a European level. These are the so-called "Lamfalussy Level 3 Committees", namely the Committee of European Banking Supervisors (CEBS), the Committee of European Insurance and Occupational Pensions Committee (CEIOPS) and the Committee of European Securities Regulators (CESR). There are, however, various difficulties with bodies of this kind. First of all, each Committee is confined to its stated market segment; there is no Committee or other body charged with the oversight of broader, systemic risks. Moreover, the existing Committees are of an advisory nature only; they have no power to issue legislative measures which are binding on Member States.

In November 2008, the Commission mandated a High Level Group chaired by Jacques de Larosière to put forward recommendations on how to strengthen European supervisory arrangements. This Group issued a final report on 25 February 2009, which proposed a two-tier supervisory framework, emphasising both macro and micro financial supervision. Perhaps unsurprisingly, there is a focus on providing enhanced powers beyond the right merely to issue advice.

The Commission welcomed and supported the main elements of the Group's recommendation in its Communication "Driving European Recovery" issued on 4 March 2009. The latest Communication sets out the basic architecture of the new framework.

The objective of this briefing is to provide an overview of the proposals and the new regime.

Structure of the proposed supervisory regime

It is proposed that the new European supervisory regime will consist of two pillars:

  1. The first pillar will involve the establishment of a new European Systemic Risk Council (ESRC). This will supervise the macro-prudential system by monitoring and assessing threats that arise from developments in the financial system as a whole and any associated macro-economic developments.
  2. The second pillar will involve the reform of the system for micro-prudential supervision. A new European System of Financial Supervisors (ESFS) will in turn lead to the establishment of three new European Supervisory Authorities. Working within a network of national financial supervisors, it is intended that they will oversee the financial soundness of individual financial firms, thus protecting depositors and other consumers (and, correspondingly, the investor protection schemes operated by individual Member States). The structure and role of both of these pillars is outlined below.

The Communication states that the successful implementation of both pillars is essential to ensure the success of the new supervisory system and to address the regulatory issues which have arisen during the current financial crisis. The Communication further emphasises the necessity for the ESRC and ESFS to co-operate efficiently via binding co-operation and information sharing to ensure smoother interaction of supervision at macro- and micro-prudential levels.

To coincide with the new framework, the Commission also proposes the introduction of a single set of core harmonised standards that can be applied throughout the EU by all supervisors. These will take the form of a single rule book and will be designed to ensure the uniform application of rules throughout the EU.

European Systemic Risk Council

The first proposed pillar of the reforms is the establishment of a European Systemic Risk Council (ESRC) which will be an independent body responsible for macro-prudential supervision across the EU financial system, collecting and analysing information relevant for monitoring and assessing potential threats to stability that arise from macro-economic developments and developments within the financial system as a whole.

The function of the ESRC will be to monitor risks to financial stability and, where necessary, to issue risk warnings and/or recommendations appropriate to the problems which have been identified. Such warnings and recommendations, which will be channelled through the ECOFIN Council and/or new European Supervisory Authorities, may be of a general nature or may be specifically addressed to individual Member States. As is the usual position, such recommendations will have no legally binding effect, but the ESRC would have a discretion to publish its recommendations. It may be that this possibility would provide Member States with an incentive to bow to the views of the ESRC. The Communication contemplates that Member States will comply with ESRC recommendations or provide an explanation for any non-compliance.

In a wider global context, the ESRC would also closely collaborate with the IMF and the newly established Financial Stability Board. The objective would be to co-ordinate a "global risk warning system" within which the EU would enjoy significant influence.

The ESRC will be fully accountable to the European Council and the European Parliament, making at least bi-annual reports to these institutions. More frequent reports may be required in times of widespread financial distress. It should, however, be appreciated that the ESRC would be a monitoring body - it would help to identify risks but it would have no role in crisis management.

Membership of the ESRC will be comprised of the Governors of the central banks of the Member States, the President (who will be Chairperson) and Vice President of the European Central Bank (ECB), the Chairpersons of the three European Supervisory Authorities, a member of the European Commission, and a person elected by the ESRC to be Vice-Chairperson (most likely from a Member State from outside the eurozone).

A senior representative of the national supervisory bodies may accompany a central bank governor at each ESRC meeting in an observer capacity, and the Chairperson of the Economic and Financial Committee (EFC) will also have observer status.

Meetings will be held at least quarterly, or more frequently in times of financial distress. Whilst both members and observers can attend and speak at the meetings, only the ESRC members would be allowed to vote, with decisions being taken on a simple majority basis. The ESRC will thus in effect be a committee of central bankers, rather than financial supervisors. This is, of course, logical because overall systemic stability is a responsibility assigned to central banks, which sit at the apex of national monetary systems.

European System of Financial Supervisors

The second proposed pillar of the reforms is a new system of European System of Financial Supervisors (ESFS) which will focus on micro-prudential supervision via a framework that combines national-based supervision of financial firms by national supervisory authorities and a centralisation of specific tasks at a European level. The Communication states the expectation that this will result in harmonised rules as well as coherent supervisory practices and enforcement.

The first element of the ESFS is the National Supervisory Authorities e.g. the Financial Services Authority in the United Kingdom. On a day to day basis, supervision of financial entities will remain the responsibility of these national authorities.

The second element of the ESFS involves the creation of three new and independent European Supervisory Authorities with increased responsibilities, defined legal powers and greater authority. These will replace the three existing Committees of Supervisors (i.e. CEBS, CEIOPS and CESR).

The new authorities will be a European Banking Authority (EBA), a European Insurance and Occupational Pensions Authority (EIOPA), and a European Securities Authority (ESA).

The chairpersons of the new European Supervisory Authorities will be full-time independent professionals and will be appointed for a period of five years. Arrangements of this kind are designed to ensure the independence of the individuals concerned, and their freedom from political pressure or interference.

These new European Supervisory Authorities will:

  1. ensure a single set of harmonised rules, by developing binding technical standards in specific areas, and drawing up interpretive guidelines which the national authorities will use in making individual decisions;
  2. ensure consistent application of the harmonised EU rules and assist the national supervisory authorities in doing so by facilitating dialogues and resolving issues between disputing national supervisory authorities. It is also proposed that a mechanism should be put in place to ensure compliance by national supervisory authorities with the harmonised rules. This would give the European Supervisory Authorities investigatory powers and the power to make recommendations, and will be backed up by recourse to the Commission should recommendations be ignored. The details of these particular proposals have yet to be finalised;
  3. ensure a common supervisory culture and consistent supervisory practices by e.g. developing common training programmes and observing meetings of the colleges of supervisors;
  4. have full supervisory powers for some specific entities with a Europe-wide reach (e.g. credit rating agencies, EU central counterparty clearing houses) with responsibilities including powers of investigation, on-site inspections and supervisory decisions;
  5. ensure a coordinated response in crisis situations by facilitating co-operation and exchange of information, acting as mediator where required, verifying the reliability of relevant information, and assisting national supervisory authorities in making and implementing decisions;
  6. collect micro-prudential information by aggregating the information emanating from national supervisors, and setting up and managing a central European database; and
  7. undertake an international role in respect of certain supervisory activities.

Each of the new European Supervisory Authorities will have a Board of Supervisors comprised of high-level representatives of the national supervisory authorities, and the relevant Chairperson, as well as representatives of the Commission, the ESRC and the relevant supervisory authorities from EFTA-EEA countries, which will all have observer status. Thus, in contrast to the ESRC, the European Supervisory Authorities will be dominated by regulators (rather than central bankers).

Reaction to the Communication

In the United Kingdom, there has been a cautious response to the proposals. In the City there is resistance to giving EU bodies any binding powers on the supervisory front, and UK officials have also responded in a lukewarm manner, describing the proposals merely as "a starting point for further discussions".

On 3 June, addressing MPs on the House of Commons' European scrutiny committee, the City minister Lord Myners stated that he broadly endorsed the proposals outlined in the Communication. However, the Government was concerned by three aspects.

Firstly, whilst the general principle of harmonisation in the regulation of the finance markets was accepted, concern was raised that this should be enforced at national level, and that there should not be EU-level supervision of entities with a pan-European reach.

Secondly, the United Kingdom is concerned about the proposal for binding mediation by the European Supervisory Authorities, and their proposed power to decide disputed issues in the last resort. Lord Myners stated that "This cuts across the basic principle of vesting supervision in national authorities".

Finally, there are also reservations about the composition of the ESRC, with the president of the ECB currently proposed to be Chairman. Lord Myners stated that the ESRC should be fully independent of the ECB. As a non-eurozone Member State, the United Kingdom is perhaps understandably reluctant to extend the influence of the ECB in this area. It must also be said that the new authorities are intended to operate on a pan-European basis, and this is not synonymous with the eurozone.

In Germany, there has been a slightly more enthusiastic response to the Communication, with deputy finance minister Jörg Asmussen stating that Germany would support the proposals. However, he also stated that a "lot of difficult questions" would need answering before detailed legislation was presented. Germany has particular concerns on the disclosure of country-specific information in the ESRC's recommendations, and would like to see clarification of the relationship between national supervisors and the ESFS. Germany would also like to see the ESRC come under the authority of the European System of Central Banks, rather than being an EU agency. Again, this illustrates the possible tensions between eurozone and non-eurozone Member States.

One concern shared by the United Kingdom and Germany is that the European Supervisory Authorities might adopt decisions that could potentially detract from parliaments' sovereign rights over the use of public funds. Mr Asmussen cited an example scenario where one country could be forced to rescue a bank, stating "we may need a debate about a form of burden-sharing rule".

Next steps

The Commission has invited the European Council to accept the proposals, and has opened a public consultation on the Communication with a deadline of 15 July 2009.

It is anticipated that there will be detailed legislation in the early autumn, with the aim that, following further consultation, the new supervisory framework would come into effect during 2010.