Introduction

On 20 September 2017, the European Commission made proposals[1] to strengthen the regulatory and supervisory powers of the three European Supervisory Agencies (ESAs) namely the European Securities and Markets Authority (ESMA), European Banking Authority (EBA) and the European Insurance and Occupational Pension Authority (EIOPA). To become legally binding, the proposals must be approved by the European Parliament and the European Council. The proposals are part of the Commission’s plan to create more integrated financial markets, and to complete the Capital Markets Union and Banking Union. The EU has increasingly used regulations to implement new requirements in financial services instead of using directives which require member states to adopt national laws to implement the requirements. The intention has been to iron out local member state discrepancies. However, it is apparent that there are still differences in the application of EU regulations by national regulators and that this leads to distortions across the EU. The Commission considers that more integrated financial markets supervision is necessary and that enhancing the powers of the ESAs is key to achieving that objective.

The Commission proposes that the ESAs are to be granted new supervisory powers and responsibilities, changed governance structures and more funding. In particular, ESMA will be given greater powers to supervise directly certain regulated entities and activities, becoming responsible for:

  • the approval of prospectuses of third-country issuers and certain other prospectuses;

  • the direct supervision of administrators of critical benchmarks and of benchmarks provided in third countries that can be used in the EU; and

  • the direct supervision of data reporting service providers.

These new powers of the ESAs are significant in light of Brexit. Many of the new powers are focused on the regulation and supervision of entities established outside of the EU that access EU markets. For prospectuses in particular, the convergence of European approvals for third countries will put ESMA and the post-Brexit UKLA in a duopoly of onshore regulators in Europe.

Increased Powers for the ESAs

The Commission proposes that the ESAs are to be given increased powers to promote the convergence of day-to-day supervision by national regulators, setting ‘Strategic Supervisory Plans’ against which national regulators will be assessed. These plans will lay out the ESAs’ priorities, with the aim of promoting the consistent application of EU law and greater harmonisation.

The ESAs will be given a new role in controlling and monitoring the extent to which EU financial institutions significantly outsource risks to a non-EU country. In particular, the Commission proposes that the ESAs will be able to provide recommendations and opinions to national regulators when notified that a financial institution that uses the EU passport intends to significantly outsource risks to a non-EU country. This reference to outsourcing highlights the possibility of UK headquartered organisations seeking authorisation in an EU Member State but subsequently outsourcing much of their operations back to the UK. The supervision of such matters could become an ESA competency, potentially reducing the risk of an intra-EU race to the bottom on standards.

In the context of Brexit, it should be noted that the ESAs will be required to assist the European Commission in preparing its equivalence decisions on whether a third country has an equivalent framework for supervising the relevant financial market participant. The ESAs will also be responsible for on-going monitoring of developments in third countries and, in that context, submitting an annual confidential report to the European Commission.

However, the power of the ESAs to develop guidelines and recommendations will be safeguarded by two different tools. The first will require a cost-benefit analysis to be undertaken each time an ESA develops guidelines or recommendations. The second tool will allow the relevant ESA stakeholder groups to consider whether the ESA is exceeding its competency in issuing guidelines or recommendations and to issue an opinion to the European Commission for it to consider the case.

The governance structure of the ESAs is also set to change. It is proposed that each ESA will have a new Executive Board which will replace the existing Management Board. The Executive Board will have decision-making powers over national regulators in certain areas such as dispute settlements and breaches of EU law, as well as the competency to conduct independent reviews of national regulators. This would represent a transfer of competencies away from the Board of Supervisors which is composed of the heads of national regulators. The Executive Boards would be composed of full-time members who are shortlisted by the Commission and appointed by a decision of the European Council, ensuring the ESAs are highly EU-orientated bodies.

The Commission proposes that the private sector should take a greater role in financing the ESAs. The supervisory work of the ESAs is currently financed by the EU budget and national regulators’ budgets. Only entities under the direct supervision of ESMA (i.e. trade repositories and credit rating agencies) have made direct financial contributions to date. Under the proposals, financial institutions indirectly supervised by the ESAs will make annual contributions, proportionate to their size.

ESMA

The Commission proposes that ESMA’s powers are enhanced in several ways. These are discussed in more detail below. In addition, there are proposals to align ESMA’s powers and remit with those of the EBA, including giving ESMA responsibility for developing and maintaining an EU handbook on supervising financial institutions.

Benchmarks

The Benchmark Regulation,[2] which will be fully applicable from 1 January 2018, sets out authorisation and registration requirements for benchmark administrators, including third-country entities, and the requirements for governance and control of administrators. It provides for different categories of benchmarks depending on the risks involved, imposes additional requirements on benchmarks considered to be “critical” and gives powers to national regulators to mandate, under certain conditions, contributions to or the administration of critical benchmarks. Under the Commission’s proposals, ESMA would become responsible for the supervision of critical benchmarks — EURIBOR and EONIA — in place of national regulators. The Commission’s view is that the existing requirement to form colleges of supervisors for some critical benchmarks already indicates that supervision by a single national regulator is inappropriate. The concern is that the large supervisory colleges will not be able to respond well enough in a crisis situation and therefore supervision of all administrators of critical benchmarks should move to ESMA. It is also proposed that the conditions to be satisfied for the European Commission to designate a benchmark as critical be narrowed with only the reference of a volume over EUR 500 billion serving as a factor.

ESMA would also become the regulator for the endorsement of all non-EU benchmarks that are used in the EU. Notably, several important benchmarks such as the LIBOR, FTSE Index,[3] ISDAFIX and the ICE BRENT INDEX will be non-EU benchmarks after Brexit.[4][5] The Benchmark Regulation states that benchmarks provided in third countries can be used in the EU if they are either recognised as being subject to the same regime established under the Regulation or if a national regulator endorses the benchmark. The proposal to move this endorsement power and the resulting supervisory role to ESMA is based on the belief that third-country benchmark administrators might seek access to the EU through an EU member state that is not as rigorous as others in its requirements.

Data Reporting Service Providers

Data reporting services are an EU-wide business with an inherent cross-border element. The proposals would amend the incoming Markets in Financial Instruments Regulation (MiFIR)[6] to establish ESMA as the sole authorisation and supervisory body for data reporting services such as approved publication arrangements, which is the service of publishing post-trade transparency reports on behalf of investment firms. ESMA will also authorise and supervise consolidated tape providers who collect post-trade transparency reports of specific financial instruments from regulated markets and then consolidate these reports into a continuous data stream, providing price and volume information per financial instrument. ESMA would provide this supervision and authorisation instead of the national regulator where the data service providers are established.

Prospectuses

The Commission also wishes to streamline the process of prospectus approval by establishing a single market entry point for non-EU issuers. It is proposed that ESMA will become responsible for the scrutiny and approval of:

  • prospectuses of non-EU issuers; and
  • with regard to all issuers:
  • prospectuses of issuers in specific industries (property, mineral, scientific research and shipping); and
  • prospectuses for certain wholesale non-equity and asset-backed securities.

These prospectuses are considered by the Commission to have the greatest cross-border element and risks of divergence by national regulators. It is unclear how significant in practice the split in responsibilities between ESMA, as regards prospectus approval, and the national regulator, as regards the assessment of eligibility for listing, may be, particularly for equity issuers. Under the proposals, ESMA will also supervise the marketing materials (known as “advertisements” under the Prospectus Directive) related to these types of prospectus.

Collective Investment Funds

The EU recently introduced specialized fund structures to encourage investment in innovative small and medium-sized enterprises, social undertakings and in the real economy, namely EuVECAs, EuSEFs and ELTIFs.

The Commission proposes to establish ESMA as the single supervisory body for these collective investment funds and their managers. Rather than the funds and managers being supervised by and registering with national authorities, they would be directly supervised by ESMA and would apply to ESMA for registration. Where a EuVECA or EuSEF fund is managed by an authorised alternative investment fund manager (AIFM) under the Alternative Investment Fund Managers Directive (AIFMD), ESMA will also be the competent authority and will supervise the AIFM’s compliance with the relevant national law implementing the AIFMD.

Furthermore, changes are proposed to the text in MiFIR to clarify that the intervention powers of ESMA and national regulators to temporarily prohibit or restrict in the EU the marketing, distribution or sale of certain financial instruments or a type of financial activity apply to UCITS investment companies, managers of UCITS and to Alternative Investment Fund Managers in certain circumstances.

Changes to the Supervision of CCPs

In June 2017, the Commission proposed that ESMA be given more powers in authorising EU CCPs and in recognising and supervising non-EU CCPs. The Commission has proposed the establishment of a new body within ESMA, the CCP Executive Session.[7] The CCP Executive Session will be responsible for handling tasks related to CCPs, with a particular focus on supervising non-EU CCPs. In addition, ESMA would become responsible for the controversial “location policy” — being able to determine that a non-EU CCP is too systemically important to be recognised and needs to be established in the EU.

Market Abuse Investigations

The Commission proposes that ESMA take a greater role in coordinating market abuse investigations that have a cross-border element. To enable this, ESMA will collect information on transactions in financial instruments directly from market participants in order to build its market expertise. Where there is well-founded suspicion of market abuse with a cross-border element, ESMA will be able to recommend that national regulators begin an investigation and exchange relevant information with each other and with ESMA.

Proposals for the EBA

The EBA will be covered by the proposals which apply to all the ESAs, including the enhanced supervisory convergence, the governance structure changes and the new funding arrangements. No enhanced powers are being proposed at this stage, although the EBA will be charged with developing and maintaining an EU resolution of financial institutions handbook.

Proposals for EIOPA

In addition to the general proposals for ESAs, the role of EIOPA will be enhanced in relation to its supervision of internal solvency capital models used by insurers.[8] The Solvency II Directive provides that insurance and reinsurance undertakings may use internal models for solvency capital requirements, as opposed to the standard formula.[9] However, there are apparently inconsistencies in the requirements of national regulators for internal models and in response, the Commission plans to increase the role of EIOPA. EIOPA will be able to request information from national regulators, issue opinions and guidelines, and settle disagreements between relevant regulators. EIOPA will also be tasked with developing and maintaining an EU supervisory handbook on the supervision of those financial institutions within its remit.