Provisional texts containing the political agreement with regard to the proposals for reform of the European System of Financial Supervision (ESFS) were published in April, just prior to the dissolution of this European Parliament. The proposals came about following a comprehensive evaluation of the ESFS finishing in 2017 and were always going to be controversial given the tension between the European Commission’s wish to extend the powers and remit of the three European Supervisory Authorities (ESAs – the EBA, ESMA and EIOPA) and the Member States’ desire to hold onto control of financial supervision at a national level. Brexit added further fuel to the controversy with several of the proposals giving the ESAs wide additional powers over third-country activities including those of the UK post-Brexit.

It is not surprising then that a majority of the Member States wanted the proposals watered down and that the political agreement reflects this reality. In fact it took one and a half years to conclude negotiations and the European Parliament alone submitted 1300 amendments to the Commission’s text. Indeed, right up until the end of the adoption process there was a consistently high threat that only the AML provisions in the text would be agreed upon.

Political pressure from both the Commission and the European Parliament was so high that the Member States were practically forced into a compromise – with some healthy encouragement from some of the largest Member States including France. The Romanian Presidency leading the discussions at the time, made use of a “silence procedure” to get the Council position concluded in preparation for final negotiations with the European Parliament. This tactic had been successful on other sensitive files where limited time was available for further meetings (here a written procedure is used). The Presidency, in a way, was able to “call the Member States’ bluff” hoping that EU countries would be unable to form blocking minorities so quickly and waiting to see if any objections would be raised at ambassador level. Ambassadors are tasked with signing off provisional agreements across legislative proposals in all sectors meaning that generally tensions are less high when it comes to the details of a proposal and where Member States are more likely to give in on one file in exchange for something in another area entirely.

The European Parliament on its side was particularly keen to secure an agreement given the resonance of the file in the run up to the European elections. It also tried to carve out a more significant role for itself – for example by introducing amendments that would give the European Parliament observer status in the individual ESA boards of supervisors.

Indeed, if it weren’t for the end of the current political mandate, there was a high risk that the proposal would not have been adopted at all. It was a gamble that many would say paid off. In the end the time pressure meant that all sides recognised it was either a deal now and on limited changes or having to wait considerably longer for an equally uncertain outcome – it’s not a given that more time would have led to a more ambitious end product.

What we are hearing as a result, informally though, is that although the Commission is pleased an agreement was reached, the new Commissioner may look to enhance the powers of the three ESAs and especially of ESMA (given the importance of completing the CMU agenda) in other ways in the coming mandate. The result is certainly a compromise, for some, one that came at too high a price. The Green shadow rapporteur in the European Parliament, Sven Giegold, remarked “Given the divergence of Parliament’s and Council’s initial positions, conclusion of the negotiations brings relief for a reform that was on the edge of the abyss. However, it is irresponsible that EU governments blocked a true European restart for common financial supervision”.

Key features of the new legislation (contained in two Regulations amending (i) the individual ESAs Regulations and (ii) the Regulation establishing the ESRB) include:

  • a larger role for the ESAs in the annual monitoring of continued compliance with the conditions of equivalence by third countries with EU financial services legislation. The ESAs will issue a confidential report to the Commission in respect of all equivalent third countries to enable the Commission to decide whether to maintain, modify or withdraw an existing equivalence decision. The report is to focus in particular on implications for financial stability, market integrity, investor (or, for EIOPA, policyholder) protection and the functioning of the internal market. This is a substantial revision of the original proposals where the ESAs were to be given the role of monitoring and reporting on third country regulatory regimes when third countries sought to be deemed equivalent, as well as on an on-going basis;
  • informal platforms will be established within each ESA to foster supervisory convergence and to avoid regulatory arbitrage by both EU and non-EU firms. These informal platforms for the exchange of information and experience by national competent authorities replace the (much more controversial) original proposals to give the ESAs a veto power over decisions by national regulators to permit firms in their jurisdiction to outsource or delegate activities to third country parties (including the UK post-Brexit). Whilst the remit of these platforms is much broader in scope than just outsourcing, the UK sees this as a significant improvement on the proposed veto power;
  • a new supervisory tool of the “No action letter” to be given to the ESAs enabling a non-binding recommendation of forbearance to be made to national regulators and to the Commission (including suggestions for amendments to EU law) with respect to the application of EU law “when market confidence, consumer protection, the orderly functioning of financial markets or the stability of the Union is at risk”; and
  • the direct supervisory responsibilities of ESMA are to be expanded to include (i) certain financial benchmarks including those administered by third country firms but used within the EU. Crucially this does not include LIBOR which will remain under the jurisdiction of the FCA (prior to Brexit); and (ii) data reporting services providers. However a proposal by the European Parliament to make ESMA the supervisor for non-EU central securities depositories (CSDs) and trading venues (under the CSD Regulation) was rejected and replaced by a requirement for a review into this matter every three years: this will be seen as a positive result for UK CSDs.

In addition, there are a few minor changes to the significant way the ESAs are managed and run, although the major changes originally proposed in this area were nearly completely blocked by the Member States.

An additional (less controversial) Directive expands the powers of the EBA to tackle money laundering following various banking scandals involving European financial institutions.

The timing of the application of these measures remains uncertain in the UK due to lack of certainty over whether there will be a ratified Withdrawal Agreement (and the consequential transitional period). If there is a transitional period the UK will stay in the single market until at least December 2020 and be subject to these measures, whilst losing its rights of representation and voting rights at EU level (including sitting on the ESAs boards of supervisors).

The legislative package is included in the UK’s Financial Services (Implementation of Legislation) Bill currently going through the House of Commons to “on-shore” this legislation. Whilst the House of Commons European Scrutiny Committee has said this might seem counterintuitive given the legislation deals with EU bodies, the Bill enables the UK Treasury to implement the legislation with any adjustments it considers appropriate. The Committee suggests the Treasury could use this to enable the UK regulators to share confidential information with the ESAs in return for EU investment firms being able to continue outsourcing certain operations to UK-based entities after Brexit.