FinancialMarketSpecialEUMonitor84
Author
Bernhard Speyer
+49 69 910-31735
bernhard.speyer@db.com
Editor
Barbara Böttcher
Technical Assistant
Sabine Kaiser
Deutsche Bank Research
Frankfurt am Main
Germany
Internet: www.dbresearch.com
E-mail: marketing.dbr@db.com
Fax: +49 69 910-31877
Managing Director
Thomas Mayer
The new European System of Financial Supervision (ESFS) is
conceptually convincing, but complex. Intertwining macro-prudential and
micro-prudential supervision draws the right conclusions from the crisis, but the
design of the two pillars of the EU‘s new supervisory system appear overly
complex. Institutional arrangements and decision-making processes seem
cumbersome and could impair the effectiveness of the arrangements.
Success of macro-prudential supervision will depend crucially on the
quality of the analysis of systemic risks by the European Systemic Risk Board
(ESRB) and its willingness to interpret its mandate widely. Systemic risk has many
sources; hence, the ESRB should have a wide purview.
Initially, the ESRB will probably be cautious in its recommendations.
Many conceptual questions on macro-prudential supervision are still not resolved
and tools for macro-prudential control are untested. In addition, experience must
be gained on how authorities and markets react to warnings and recommendations
from systemic risk supervisors.
The European Supervisory Agencies (ESAs) are an improvement on
the Level 3 committees, but still fall short of what would be needed.
The ESAs will help to create a single rule book for financial supervision and to
align supervisory practices. But micro-prudential supervision will continue to sit in
an uneasy half-way house between national sovereignty and pan-European
arrangements.
We remain convinced that truly pan-European supervisory powers are
desirable. The financial crisis has demonstrated that the co-existence of national
supervision and integrated financial markets is untenable. Hence, the choice is
between either preserving an integrated financial market in the EU and creating a
corresponding EU-level supervisory framework for it, or allowing the refragmentation
of Europe‘s financial markets. The choice is clear.
August 4, 2011
Financial supervision in the EU
Incremental progress, success not ensured
EU Monitor 84
2 August 4, 2011
Financial supervision in the EU
August 4, 2011 3
Crisis exposed weaknesses in
financial supervision
ESFS as comprehensive and
integrated framework
The financial crisis revealed weaknesses not only in the risk
management of many financial institutions, but also in the design of
supervisory structures and the execution of financial supervision.
This holds true not least for financial supervision in Europe, whose
institutional set-up had already been contentious prior to the crisis.
Following the crisis the structure of financial supervision came under
renewed criticism. The weaknesses were analysed comprehensively
in the report of the De Larosière Group, which also delivered the
blueprint for the subsequent reforms that took effect on January 1
st
this year.
I) The ESFS
The new institutional structure of financial supervision in the EU is
explicitly designed as a comprehensive and integrated framework
comprising macro- as well as micro-prudential supervision. The
former is in the hands of the newly created European Systemic Risk
Board (ESRB), the latter rests on the interplay between the national
competent authorities and the three European Supervisory Agencies
(ESAs). These institutions are brought together in the so-called
European System of Financial Supervision (ESFS). Combining them
under a single roof recognizes that only the effective integration of
micro- and macro-prudential supervision will ensure that risks to
financial stability will be identified and addressed.
The obvious challenge will be to integrate both processes not only
on paper, but also in practice. The institutional set-up and the legal
foundations of the ESFS aim to ensure that this is the case: on the
one hand, it creates cross-membership amongst the institutions, i.e.
the ESA chairs are full members of the ESRB and representatives of
the ESRB are non-voting members of the ESA Boards of Supervisors.
On the other hand, in the regulations setting up the ESAs
and the ESRB all parts of the ESFS are explicitly mandated to
cooperate and to ensure an appropriate and reliable flow of
information between them.
The ESFS not only combines macro- and micro-prudential
supervision, but also national and EU-level elements. While the dayEuropean
System of Financial Supervision (ESFS)
ESRB
(Frankfurt/M)
Chair: J.-C. Trichet
Vice-Chair: M. King
European Supervisory Authorities (ESAs)
EBA
(London)
Chair:
Andrea Enria
ED: Adam Farkas
ESMA
(Paris)
Chair:
Steven Maijoor
ED: Verena Ross
EIOPA
(Frankfurt/M.)
Chair:
Gabriel Bernardino
ED: Carlos Montalvo
Joint Committee of the ESAs (rotating chair)
(incl. Sub-Committee on Financial Conglomerates)
Board of Appeal
(6 members, 2 each nominated by each ESA Mgt. Board)
National competent authorities of EU member states
Source: DB Research, 2011 1
EU Monitor 84
4 August 4, 2011
Macro-prudential supervision
closes a gap
ESRB entitled to issue
recommendations
International comparison instructive
to-day execution of financial supervision remains in the hand of
national authorities – with them acting in concert, such as in supervisory
colleges, where needed – the EU-level is strengthened in
order to ensure a greater consistency of supervisory rules and
practices as well as a comprehensive analysis of system-wide risks.
II) Macro-prudential supervision: the ESRB
The rationale
The need to attach greater importance to macro-prudential analysis
within the overall supervisory framework is one of the lessons drawn
from the financial crisis. It is aimed at plugging a gap in the framework
exposed by the insight gained during the crisis that all financial
institutions, individually, can satisfy supervisory requirements, yet
systemic risk can build up. In addition, too often in the past, potential
risks to financial stability had been identified, but tools were lacking
to translate this analysis into corrective action.
1
Hence, it is
necessary to complement traditional micro-prudential supervision
with a systematic analysis of systemic risks and a framework for
targeted action to address these risks. The term ―macro-prudential
supervision― has been established in recent years for this type of
financial supervision.
A framework for macro-prudential supervision is not only being
established in the EU, but in all major G20 countries.
2
In the EU, the
task of macro-prudential supervision has been entrusted to the
ESRB. The ESRB is mandated to monitor, assess and prioritise
threats to financial stability in the EU. This mandate covers all
segments and areas of the financial markets, including market
infrastructures and guarantee schemes. It will perform stress tests to
determine the sensitivity of the financial system to shocks.
Based on its analysis, the ESRB is entitled to issue risk warnings
and recommendations for remedial action, if it comes to the conclusion
that such action is required. The ESRB is also tasked to
monitor the implementation of these recommendations. However,
the ESRB neither has macro-prudential tools directly at its disposal
(e.g. the right to impose counter-cyclical capital charges) nor does it
have sanctioning powers against financial institutions or authorities
that fail to respond to a risk warning.
In this context, it is interesting to compare the ESRB with its peers
elsewhere. Compared to its US counterpart, the FSOC, the ESRB
has a narrower mandate. It is therefore unsurprising that its focus,
so far, has been on macro-economic risks rather than issues
stemming from regulatory developments. The FSOC is involved
more closely in designing financial regulation and in assessing the
economic implications of new financial regulation. More importantly,
it is also mandated to identify and designate financial institutions as
systemically important and subject them to appropriate rules.
3
The
1
In this context, it was also revealed that central banks, while clearly having an
impact on financial stability through their monetary policy, lack the tools to tackle
threats to financial stability. Specifically, it is understood that interest rate policy is
too blunt an instrument for this purpose, as it cannot be targeted on specific
sources of systemic risk; there is also a risk that fighting financial instability may be
incompatible with the primary objective of monetary policy, i.e. safeguarding price-
stability.
2
In the US, for example, the Financial Stability Oversight Council (FSOC) has been
established as the systemic risk supervisor and in the UK the task will be in the
hands of the Financial Policy Committee (FPC).
3
Art. 23 of the Regulation setting up the EBA and Art. 23 of the Regulation setting
up ESMA gives EBA the task to develop the criteria for the identification and
Financial supervision in the EU
August 4, 2011 5
ESRB – General Board
The ESRB‘s General Board has 65 members:
— ECB president and vice-president
— 27 central bank governors
— ESA chairs (3)
— COM representative
— Chair and 2 vice-chairs of ASC
— Chair of ATC (currently Stefan Ingves)
— President of Economic and Financial
Committee (EFC) (non-voting; currently
Vittorio Grilli)
— One high-level representative per Member
State of the competent national
supervisory authorities (non-voting)
ESRB – Steering Committee
The ESRB Steering Committee has 14
members:
— the Chair and first Vice-Chair of the ESRB
— the Vice-President of the ECB
— four other members of the General Board
who are also members of the General
Council of the ECB, elected by and from
among the members of the General Board
who are also members of the General
Council of the ECB (currently Marek
Belka, Mario Draghi, Athanasios
Orphanides, Jens Weidmann)
— a representative of the European
Commission
— the Chairpersons of the 3 ESAs
— the President of the EFC
— the Chair of the Advisory Scientific
Committee (ASC)
— the Chair of the Advisory Technical
Committee (ATC)
Advisory Technical Committee (ATC)
The ATC has 62 members:
— a representative of each national central
bank of the Member States
— a representative of the ECB
— one representative per Member State of
the competent national supervisory
authorities
— one representative each of the three
ESAs
— two representatives of the European
Commission (EC)
— a representative of the Economic and
Financial Committee (EFC)
— a representative of the Advisory Scientific
Committee (ASC)
The current chair is Stefan Ingves, President
of the Sveriges Riksbank.
focus of the UK‘s FPC, in turn, is on risks in the banking sector.
Thus, the early work in its existence has been concentrated on
issues such as forbearance exercised by banks vis-à-vis their
debtors and on encouraging banks to bolster their capital base. This
focus is unsurprising given the closeness of the FPC to the Bank of
England and the latter‘s newly acquired responsibility for banking
supervision.
Institutional set-up
The ESRB is an EU-level body mandated to act in an impartial way
and solely in the interest of the Union as a whole. It shall not take
instructions from member states, Union institutions or any other
interested party.
The highest decision-making forum of the ESRB is the General
Board, consisting of 37 full – i.e. voting – members and 28 nonvoting
members (for a list of members, see box). The ESRB is
based in Frankfurt at (sic!) the ECB. It is chaired, for at least the first
five years of its existence, by the president of the ECB.
As the General Board of the ESRB is a large body, decisions will be
prepared by a Steering Committee, which will also set the work
agenda for the ESRB. The Steering Committee has 14 members.
The work of the Steering Committee and that of the ESRB as a
whole is supported, with regard to both content and organisation, by
a Secretariat. The Secretariat will be funded and supported by the
ECB. Its head is appointed by the ECB, in consultation with the
General Board of the ESRB.
4
The Advisory Technical Committee
(ATC), whose composition essentially mirrors that of the General
Board, will do the groundwork on technical analysis related to the
work of the ESRB.
To pass risk warnings and recommendations, a 2/3 majority is
needed in the General Board. Risk warnings can either be specific,
i.e. referring to a specific issue, country or market segment, or
general. Risk warnings can be directed at authorities in the EU as a
whole, to one or more member states, to the ESAs or to national
measurement of systemic risk and to subject credit institutions that may pose a
systemic risk to strengthened supervision.
4
Mr. Francesco Mazzaferro has been appointed Head of the ESRB Secretariat in
June 2011.
General Board
(decision making)
Steering Committee
Prepare Board decisions
Monitor progress of ESRB‗s work
Secretariat
Day-to-day business;
analytical,
administrative,
logistical support
Advisory Scientific
Committee
(15 + chair)
ESRB – structure
Advisory Technical
Committee
(mirrors of General
Board composition)
Source: DB Research, 2011 2
EU Monitor 84
6 August 4, 2011
ESRB may make warnings public
ESRB structure appears unwieldy
ESRB's soft powers should not be
underestimated
authorities, and they can include suggestions for appropriate
legislative initiatives. Recommendations shall have a specific
timeline for a response and addressees need to react to these
recommendations on a ―comply or explain‖ basis.
If action by the addressee is deemed inadequate, the ESRB may
decide, with a 2/3 majority, to inform the Council or the responsible
ESA with a view to having them pursue the matter further. Moreover,
as quasi the ultimate weapon, the ESRB may, also with a 2/3
majority, choose to make its warning and recommendation public.
Assessment
In assessing the chances of success for the ESRB, four aspects
appear to be crucial: The institutional set-up of the ESRB, its
powers, the instruments available and the quality of its analysis, and
the ESRB‘s interpretation regarding the scope of its mandate.
Institutional set-up: Without a doubt, the size of the ESRB is a
hindrance to its effectiveness. With its 65 members the General
Board is too unwieldy. It is interesting to note that the ESRB‘s peers
– the Financial Stability Oversight Council (FSOC) in the US and the
UK‘s Financial Policy Committee (FPC) – are considerably smaller
in size (10 voting and 5 non-voting members in the case of the
FSOC and 11 voting and 2 non-voting members in the case of the
Interim FPC). For practical purposes the effectiveness of the ESRB
will therefore hinge on the performance of the Steering Committee
and the Secretariat. While there is good reason to assume that
these two will be able to act efficiently, the size of the General Board
will come into play whenever decisions need to be taken by the
ESRB, especially in light of the fact that 2/3 majorities are required
for the ESRB to take decisions.
Powers: There has been a heated discussion on whether the ESRB
will have sufficient teeth to bite, i.e. whether its recommendations
will be heeded by addressees. As stated above, the powers
available to the ESRB are, indeed, soft in character. It has no hard
sanctioning powers. The ESRB cannot order other institutions or
actors to alter their behaviour, it can merely issue recommendations.
Ultimately, therefore, the success of the ESRB will depend on
whether its authority is recognised by the other authorities.
However, it would be wrong to measure the ESRB‘s influence in
terms of hard powers only. Specifically, one should not underestimate
the importance of sound analysis and communication. The
higher the quality of the analysis and the less refutable the quality of
the recommendations for addressing the problem identified, the
more difficult it will be for addressees to ignore the warnings
received. Hence, the success of the ESRB will crucially depend on
the quality of its analysis and its communication to the markets. In
this regard, it is appropriate to recall that the ESRB can draw on the
resources of all EU central banks and supervisory authorities –
many of which are in the process of building systemic risk supervisors
themselves, so that expertise should be available in ample
quantity. The challenge will obviously be to make national authorities
share that information with their peers and the ESRB – something
that is far from being assured.
One also should not underestimate the importance of the fact that
the ESRB may decide to forward its warning to the Council or to
make it public. An addressee of an ESRB risk warning will probably
want to avoid being called upon to justify its actions in public (so-tospeak),
especially if the analysis of the risk is irrefutable.
Financial supervision in the EU
August 4, 2011 7
ESRB without own instruments
Analysis of dangers must not be
too narrow
ESRB likely to move very
cautiously initially
Incidentally, note should be taken of the fact that the ERB, at a size
of 71 members, is a quasi-public forum. It is unlikely that matters of
material substance could be kept secret in a forum of that size. In
addition, risk warnings that are made public or that are leaked to the
outside will, if convincing in their analysis, trigger market reactions
which by themselves can either achieve the desired results directly
or force authorities to take the required action. In this context, it is
probably not unrealistic to expect that, over time, the ESRB will
develop a communication style akin to that of central banks, where
special key-words will be used to signal degrees of concern about
systemic risks.
Instruments available: The importance of the quality of the ESRB‘s
analysis and of its communication policy become even more evident
in light of the fact that, beyond analysis and recommendations, it
lacks instruments to address systemic risks. The ESRB‘s tool-kit is
essentially limited to making recommendations; it does not have
access of its own instruments for macro-prudential policy. These will
have to be applied by the responsible national authorities. In this
context, it is noteworthy that the draft CRD IV leaves traditional
macro-prudential tools, such as counter-cyclical capital charges, and
variations in LTV / LTI ratios and capital requirements, in the hand of
national regulators. In order to limit the scope for arbitrage and the
risk of competitive distortions, it would be useful if the ESRB had a
coordinating role here by issuing guidelines on the design and use
of such instruments.
Interpretation of scope of mandate: Risks to systemic stability can
originate in many areas. It is therefore important that systemic risk
supervisors such as the ESRB cast their net wide. The analysis of
potential dangers to systemic stability must not be unduly limited;
specifically, it would be a matter of concern if the ESRB ignored
dangers originating in macro-economic policies, especially monetary
policy. After all, excessive lending growth, asset price bubbles, and
excessive risk-taking are almost always preceded by too loose
monetary policy.
As a corollary to advocating a broad scope of the mandate, macroprudential
supervisors should also have a broad set of instruments
at their disposal to target their interventions optimally. This, in turn,
underlines the above-mentioned point that the ESRB should have a
strong coordinating role to ensure that actions taken by the national
competent authorities are well aligned across the EU. Coordination
must also be ensured with the European Commission, as the
Commission will acquire a greater role in the context of the new EUlevel
surveillance procedure.
All in all, it would appear likely that the ESRB will move very
cautiously in its initial stages of existence. Several arguments
support this assessment:
— First, given the current precarious state of financial markets, the
ESRB – like other macro-prudential supervisors – will be careful
not to add stress to markets.
— Second, given that macro-prudential analysis and policy
instruments are still in their infancy, the precise repercussions of
their use are difficult to predict for policymakers.
— Third, if the ESRB were to issue too many risk warnings, some of
which would inevitably not materialize, its credibility could suffer.
EU Monitor 84
8 August 4, 2011
Banks need to monitor macroprudential
supervisions
ESAs replace 3L3
— Fourth, the size of the ESRB, combined with the fact that a 2/3
majority is needed in the General Board to adopt recommendations,
will tend to favour cautious warnings.
— Finally, the exercise of macro-prudential supervisory powers has
the potential to be politically controversial. On the one hand, risk
warnings by macro-prudential supervisors will often implicitly be
tantamount to criticising previous decisions by authorities that
have contributed to the accumulation of financial imbalances or
have failed to address macro-prudential risks adequately and in a
timely fashion. On the other hand, it must be recognised that
financial imbalances and asset price bubbles have, in the past,
often been allowed to build up, because, in the short-term, rising
wealth, e.g. in housing markets, was politically popular. Hence,
taking away the punch-bowl by means of macro-prudential
policies is likely to be at least as unpopular as central banks
raising interest rates to dampen an economic boom.
Against this background, it is very probable that the ESRB will only
act if it is very sure of its analysis and the effectiveness of its policy
measures. Hence, at least in the initial years of its existence it is
more likely to commit type 1 mistakes (not warning when it should
have) rather than type 2 mistakes (warning, but no subsequent
crisis).
Impact on banking sector
For banks, macro-prudential supervision may, ultimately, entail a
requirement to change business models, business practices, and
risk exposures irrespective of their own situation and risk profile.
Suppose, for instance, that the ESRB decides that there was a
bubble in residential mortgage markets and decides to lower
permissible LTV ratios. Then such a decision would affect business
opportunities of all banks in a similar way irrespective of an
individual bank‘s capital base or mortgage portfolio risk profile. This
is a marked difference to micro-prudential supervision, where
individual banks are only the target of supervisory action if there is
an institution-specific issue that requires supervisor‘s attention.
For market participants, the establishment of macro-prudential
supervisors also entails a need to monitor closely an additional actor
in financial markets. Decisions by the ESRB will affect asset prices,
market volumes and the behaviour of market participants – in fact,
that is the very purpose of macro-prudential policy. Similar to their
traditional practice of central bank watching, banks will therefore
need to watch the analyses, statements and actions of macroprudential
supervisors in order to incorporate these into their own
business decisions.
III) Micro-prudential supervision, the ESAs
The three new European Supervisory Agencies (ESAs) – EBA,
ESMA and EIOPA – build on their predecessors, the so-called level
3-committees (CEBS, CESR and CEIOPS; together dubbed the
―3L3‖), which in turn were established in the wake of the
implementation of the proposals initially developed by the Wise Men
group, chaired by Alexandre Lamfalussy.
5
Together with the national
supervisory authorities, they form the micro-prudential leg of the
supervisory system. In addition, there is a cross-sectoral Joint
Committee of the ESAs to analyse and monitor risk that cuts across
5
For a discussion of the weaknesses of the Lamfalussy structure, see Speyer,
Bernhard and Norbert Walter (2007). Towards a new structure for EU financial
supervision. EU Monitor 48. Deutsche Bank Research. Frankfurt am Main.
Financial supervision in the EU
August 4, 2011 9
Endorsement of technical standards
Under European law, only the European
Commission can formally issue delegated
acts which have been provided for in the
underlying legislation. The reason is that the
EP and Council as European legislators can
only delegate delegation powers to the
Commission, but not to a European agency,
such as the ESAs. (Powers of delegation
have been conferred on the European
Commission by the co-legislators for a period
of four years from 16. December 2010; the
powers will automatically be renewed for fouryear
periods unless revoked.) Therefore, any
technical standard developed by the ESAs as
draft law (rather than merely as a piece of
technical advice) needs to be endorsed by the
Commission. The Commission will, within
three months after receipt, check whether the
draft law developed by the ESA is in line with
EU law, the underlying legislative act and EU
interests and will then endorse the standard
fully or in parts, or may amend it. If the
Commission decides to (partly) reject or
amend the draft law, the ESA will have six
weeks to amend the proposal and resubmit it.
If, on the expiry of the six-week period, the
ESA has not submitted an amended draft or
has not taken up the Commission‘s
amendments in a way satisfactory to the
Commission, the Commission may adopt the
technical standards as it sees fit or reject
them. Both the European Parliament and the
Council have the right to object, within three
months (or within one month if the standard
proposed by the Commission is identical to
the ESA‘s proposal), to a regulatory technical
standard endorsed by the Commission. In
such a case the regulatory technical standard
may not enter into force.
ESAs stronger than 3L3
financial sectors and to ensure consistency of regulation across
sectors to the extent that materially similar activities are conducted
within them. The organisation of supervision of financial
conglomerates will also be a task of the Joint Committee.
Unlike the 3L3, the ESAs have legal personality. They are mandated
to take a pan-European perspective, transcending national interests,
and are accountable directly to the Council and the European
Parliament.
Mandate, powers and their limits
The ESAs are much stronger than the 3L3. The 3L3 essentially only
had advisory powers and could set non-binding technical guidelines.
In contrast, ESAs are tasked with ensuring that a single set of
harmonised rules and consistent supervisory practices are applied
by national authorities. The ESAs are mandated to
— draft technical standards, guidelines and recommendations in
their respective areas,
— foster supervisory convergence,
— promote a coherent functioning of supervisory colleges,
— prevent regulatory arbitrage,
— settle disputes between national supervisors,
— conduct peer reviews,
— initiate stress-tests,
— monitor and assess market developments,
— identify and measure, in collaboration with the ESRB, systemic
risk,
— promote consumer protection, and
— prohibit or restrict certain activities in emergency situations.
The ESAs have also been given explicit powers to look into
consumer protection issues. Specifically, they are mandated to set
up committees on financial innovation, which will look into the risks
inherent and the potential impact of financial innovations. In
addition, the ESAs ―may conduct an inquiry into a particular type of
financial institution or type of product or type of conduct in order to
assess potential threats to the stability of the financial system and
make appropriate recommendations for action to the competent
authorities concerned”
6
, which clearly is very close to the mandate
of the ESRB and risks some overlap in their mandates. The
committees will also look into issues such as consumer literacy and
product transparency.
There are of course other ways in which the ESAs can exert
influence. The development of supervisory agendas is one; another
is through the participation in supervisory colleges. Also, as the EBA
stress-test has demonstrated, the ESAs are able to exert influence
by means of their management of specific issues. The EBA may, for
instance, also conduct inquiries into types of institutions, products or
market conduct, thereby turning attention to certain market players
or practices. It also has a mandate to help develop resolution
regimes and crisis management.
Technical standards set by the ESAs are, after endorsement by the
European Commission (see box), binding for the national
supervisory authorities. Unlike the 3L3, the ESAs are allowed to
6
Art. 22,4 of the EBA / ESMA Regulations.
EU Monitor 84
10 August 4, 2011
ESAs can issue binding standards
No direct supervisory role
Competences in case of breaches
of EU law, ...
... lasting disagreements …
... and in emergency situations
participate in the colleges of supervisors, including on-site visits and
can request the deliberation of issues in the colleges.
The scope of areas where the ESAs can issue binding technical
standards is defined in EU financial legislation, where such
delegated powers have to be enshrined. In the case of ESMA, such
powers can currently be found in a number of pieces of legislation,
including the MiFID, the Prospectus Directive, the Transparency
Directive and the Market Abuse Directive.
7
In the case of EBA, the
CRD is the main source of delegated powers. Before passing
technical standards, the ESAs are required to hold public
consultations on the drafts of such technical standards, perform
cost-benefit analysis and seek the view of their advisory
committees, i.e. the Stakeholder Groups.
The ESAs do not have a mandate to directly supervise individual
financial institutions. This will remain the exclusive competence of
national supervisory authorities (though, as mentioned, the ESAs
are entitled to participate in the supervisory colleges which have
been set up for cross-border financial groups). However, in three
narrowly defined cases, the ESAs may take decisions pertaining to
individual institutions, which would prevail over previous decisions
taken by national competent authorities:
— The ESAs may investigate – upon request by the European
Commission, the EP, the Council, any national supervisory
authority, the Banking Stakeholder Group or on its own initiative
– alleged breaches of EU law by national authorities. If the
national competent authority is found in non-compliance with EU
law, and if it does not comply with a Commission opinion
requiring it to take necessary action and if, as a consequence of
such non-compliance, market disruptions occur, an ESA may
issue rulings directly applicable to individual institutions.
8
— The ESAs may take binding action in case of lasting disagreements
between national authorities, if mediation has failed.
Again, should one of the parties concerned not comply with the
ESA‘s ruling, the ESA may adopt an individual decision
addressed to the relevant market participant(s).
— The ESAs may adopt, in emergency situations, decisions
requiring national authorities to act or, if it does not, issue a
decision directly applicable to an individual financial institution.
Even in those circumstances the priority is on facilitating and
coordinating the actions of national supervisors. For this to occur,
the ESAs are to be invited as observers to meetings of the
relevant national competent authorities. The emergency would
have to be declared by the Council, in consultation with the
ESRB and the European Commission. An emergency is defined
as a situation where adverse developments may seriously
jeopardise the orderly functioning and integrity of the financial
markets or the stability of the whole or part of the financial
system in the EU. In such a case, if satisfactory action by
national authorities is not forthcoming, the ESA may temporarily
7
The total list comprises MiFID, TOD, Settlement Finality Directive, PD, Financial
Collateral, MAD, AIFM, UCITS, CRA, Investor Compensation Schemes.
8
If a national competent authority is found to be in breach of EU law by the ESA,
the addressee of such an ESA recommendation must respond within ten working
days. If the competent authority does not comply with EU law within one month
from receipt of the ESA recommendation, the European Commission may issue a
formal opinion requiring the competent authority to act. After that, the competent
authority again has ten working days to respond. If the authority still fails to comply,
the ESA will be able to issue directions directly to the market participant affected.
Financial supervision in the EU
August 4, 2011 11
"Safeguard clauses" protect national
interest ...
... but may only be invoked in
exceptional cases
prohibit or restrict activities deemed harmful, where the
underlying legislation provides a legal basis for such restrictions.
Bans on short-selling or the trading of sovereign CDS spring to
mind as examples from the recent past where such powers could
have been employed. The ESA may also ask the Commission to
introduce legislation to make such restrictions permanent.
So-called ―safeguard clauses‖
9
stipulate that decisions by an ESA
taken in an emergency situation or taken to settle a disagreement
between national competent authorities must not impinge in any way
on the fiscal responsibilities of a member state. This safeguard
clause responds to concerns by member states that decisions by
ESA might have consequences for national budgets without the
member state and its parliament having an ex ante say on this
matter. The safeguard clause establishes two processes, referring to
(i) a decision by an authority to solve disputes between competent
national authorities and (ii) a decision taken in response to an
emergency situation.
— In case (i), if a member state considers that a decision by an ESA
impinges on its fiscal responsibilities, it must notify the ESA and
the Commission within two weeks, explaining its case; the
decision will then be suspended. Within a month of receipt of the
notification, the Authority shall inform the member state whether
it maintains its decision or whether it amends or revokes it. If the
decision is maintained, the Council, not later than two months
later (within 10 working days in case of a decision taken in an
emergency), shall decide, by simple majority, whether the
Authority‘s decision is maintained. Should the Council not take a
decision to maintain the Authority‘s decision, the decision shall
be revoked.
— In case (ii), the member state must notify the Authority, the
Council and the Commission within three working days; again,
the decision will be suspended in case of such a notification. The
Council shall, within 10 working days, take a decision by simple
majority, as to whether the Authority‘s decision is revoked. If the
Council does not a decision to revoke the decision, the suspension
shall be terminated. If the member state insists on its
position, it can ask the Council to re-consider the matter. In such
a case, the Council will be obliged to confirm its earlier decision
or to take a new decision.
Note should be taken of the fact that the two processes differ:
Whereas in case (i), a majority must be achieved in the Council to
back the Authority‘s decision, in case (ii) a majority must be
achieved to revoke the Authority‘s decision. This appears sensible in
light of the fact that, in an emergency situation, uncertainty about the
finality of a decision should be minimised. This interpretation is
supported by the fact that the Regulation also makes clear (in Art.
38,5 of the EBA / ESMA Regulation) that member states shall only
make use of the safeguard clause when a ―significant and material‖
impact on the budget is anticipated to stem from the Authority‘s
decision.
Institutional set-up
The institutional set-up of the three ESAs is similar (see chart p. 12
for a graphical depiction using the example of the EBA). Their main
decision-making body is the Board of Supervisors, composed of the
9
These are enshrined in Art. 38 of the Regulations setting up EBA and ESMA
respectively.
EU Monitor 84
12 August 4, 2011
ESA Board of Supervisors
The Board is composed of
— the heads of the respective national
competent authorities
— the Chairperson of that ESA
— representatives from the respective two
other ESAs, from the European
Commission, and from the ESRB
Only the representatives of the national
supervisors are voting members.
heads of national banking supervisors, plus, as non-voting
participants, a chair and a representative each of the ECB, the
ESRB, the Commission and the respective other two ESAs. The
Board appoints and supervises the chairperson, and adopts
opinions and recommendations. It decides by simple majority,
except for issuing direct interventions, when qualified majority voting
will apply.
The Board of Supervisors also nominates the Management Board,
which is tasked with ensuring that the ESA fulfils its mandate on a
day-to-day basis. The Management Board is tasked with developing
the work programme and dealing with issues concerning budget and
personnel. It is chaired by a full-time professional and, in addition to
this Chairperson, is composed of six voting members drawn from
the Board of Supervisors. The Management Board decides by
simple majority. Its members shall act independently and in the sole
interest of the Union as a whole. The Board of Supervisors also
nominates the Executive Director, a full-time independent professional
tasked with managing the day-to-day work of the ESA.
Decisions by the ESAs can be appealed against at the Board of
Appeal, composed of six members, two each of which are
nominated by each of the ESAs. The members of the Board of
Appeal will be well-reputed individuals with knowledge in the
respective fields and professional experience. The decisions of the
Board of Appeal will be made by majority vote.
In order to provide a regular and organised framework for discussion
with stakeholders, the ESAs have set up Stakeholder Groups, each
comprising 30 members representing not only financial institutions
but also representatives of employees, consumers and users of
financial services.
Banking Stakeholder Group
30 members in advisory capacity
(o/w 10 financial inst., min 5 academics); appointed by Board of
Supervisors
Board of Supervisors
(heads of banking supervisors; plus: non-voting chair, ECB, ESRB,
ESMA, EIOPA, COM)
• appoints and supervises chairperson
• adopts opinions, recommendations, etc.
• decides by simple majority, except for in issuing
direct interventions, when QMV will apply
Management Board
Chairperson plus six voting members of Board of Supervisors
• elected by Board
• majority voting
• ensures that EBA fulfils mandate
• appoints Board of Appeal
• Chairperson: full-time, independent professional;
5yr renewable term
Executive Director
• full-time independent professional managing EBA
• appointed by Board
• 5 yr renewable term
nominates
EBA: Institutional set-up
nominates
Source: DB Research, 2011 3
Financial supervision in the EU
August 4, 2011 13
Joint Committee
Composition: The Joint Committee is
composed of the Chairpersons of the ESAs
and the Chairperson of any sub-committee
established by the Joint Committee, especially
the Sub-Committee on Financial
Conglomerates.
Mandate: The Joint Committee serves as a
forum for cooperation amongst the ESAs,
aiming to ensure cross-sectoral consistency,
especially in the areas of
— financial conglomerates
— accounting and auditing
— micro-prudential analyses of crosssectoral
developments, risk and
vulnerabilities
— retail investment products
— measures combating money laundering
— cooperation with the ESRB
New framework has some positive
aspects ...
... but leaves supervisory framework
in half-way house
Differences between the ESAs
While the ESAs are similar as regards their institutional set-up, they
differ in their competences. Compared to its peers, ESMA has a
greater role in regulation, being frequently referred to EU legislation
with a rule-setting role, e.g. on derivatives markets. In contrast,
EBA‘s work is more geared to prudential supervisory issues, with no
direct supervisory powers except for in the exceptional circumstances
mentioned above. ESMA also has a far broader remit of
competences, spanning securities, securities markets, clearing
houses, fund managers, and credit rating agencies (CRA). As
regards the latter it even has a direct supervisory role, as in the
regulation on credit rating agencies the right to authorize and
supervise CRA is conferred onto ESMA. ESMA is therefore unique
in being the only ESA that has direct supervisory powers. In this
context, ESMA will be given power to request information, launch
investigations and perform on-site inspections. It would be sensible
(and indeed build on the same logic) if similar powers were
conferred onto ESMA for other pan-European structures and
organisations, such as clearing houses. However, the reaction of
national competent authorities and member states to such ideas
was less than welcoming, pointing to the fact that the transfer of
direct supervisory powers to the EU-level is still anathema to many
national authorities and member states.
Assessment
The new framework for micro-prudential supervision in the EU and
the establishment of the ESAs undoubtedly has some positive
aspects. Specifically, the following aspects must be regarded as
contributions to overcoming some of the weaknesses of the
previous arrangements:
— In contrast to the work of the 3L3, ESA technical standards and
guidelines will be binding on all member states.
— The development of a single rule-book, if successfully achieved,
would be a significant step towards supervisory harmonisation. It
would not only provide the basis for a consistent treatment of
investors across the EU, but would also provide a regulatory
level playing field for financial services providers.
— The presence of the ESAs in the supervisory colleges and the
fact that national supervisors will henceforth conduct their work
under the shadow of potentially binding decisions by the ESA will
probably help to enhance the quality and consistency of
supervisory decisions. Only time will tell, though, whether this will
be sufficient to materially improve the effectiveness of
supervisory decisions.
Nonetheless, it is impossible to ignore that the new arrangement,
while addressing some of the obvious weaknesses of the previous
regime, does not mark a revolutionary change, but merely
constitutes another uneasy compromise regarding the sharing of
supervisory competences between the EU-level on the one hand
and the national level on the other. While the reform has shifted
power slightly in favour of the EU-level, the new balances is ways
apart from truly pan-European supervision. Specifically:
— Lacking substantial resources of their own
10
, ESAs will have to
rely on national competent authorities to perform their task; the
10
The combined budget of the three ESAs for 2011 amounts to EUR 40 m, funded
by obligatory contributions from national authorities, the EU's General Budget and
fees for services provided by the ESFS to national regulators such as arbitration
EU Monitor 84
14 August 4, 2011
Dependent on support from national
competent authorities
ESRB is a positive step
ESAs are a compromise
same holds true for access to data. Hence, a supportive stance
of the national authorities will be crucial to the ESAs success –
which is a precarious state of affairs, given that some national
authorities may view the ESAs as a threat to their own
competences. The peer reviews which the ESAs are tasked with
will be a crucial test-point for the credibility of the ESAs and for
their forcefulness vis-à-vis national supervisors. In this regard,
the insistence of EBA on a stringent peer review and a thorough
vetting of results in the recent EBA stress testing exercise is a
positive development, even if it may have angered some national
authorities.
— None of the ESAs has micro-prudential supervisory powers.
11
Whether or not they will be able to establish themselves as
forceful actors, will depend on their chairpersons and executive
directors. It will also depend on the willingness of the ESAs to
stand up to national authorities and to members states to assert
pan-European views and the powers of the ESAs.
— The ―half-way house-character‖ of the new arrangement also
shows in the contribution of the ESAs to crisis management: On
the one hand, EBA will have no direct supervisory powers, on the
other hand, Art. 24 of the Regulation setting up EBA tasks EBA to
“ensure it has specialised and ongoing capacity to respond
effectively to the materialisation of systemic risks (...) in
particular, with respect to institutions that pose systemic risk.”
Similarly, the ESAs must source their information through the
national competent authorities and may only in exceptional cases
address their requests directly to the institution concerned.
IV) Conclusion and outlook
Does the reform of supervisory structures in the EU amount to a
significant step and will it materially help to enhance the resilience of
the European financial system? The establishment of the ESRB as a
macro-prudential supervisor certainly fills a gap in the previous
supervisory structure. Whether the ESRB – and, for that matter,
systemic risk supervisors elsewhere – will actually manage to
identify threats to systemic stability and take appropriate course to
address these effectively is something that only time will tell. The
ESRB will certainly be able to assemble and build adequate
expertise for the task and the institutional framework for the task
appears, on the whole, conducive to the task in spite of looking
overly complex and unwieldy. However, the actual effectiveness will
ultimately hinge on the level of political support for the ESRB – a
factor more difficult to predict.
As regards the reform of micro-prudential supervision, the
establishment of the ESAs is undoubtedly another step in the
evolutionary approach that started with the Lamfalussy Process. But
it still leaves the supervisory framework in an uneasy half-way
house between national and supra-national structures for financial
supervision. This construction reflects that the structure, which took
effect at the start of the year, is a hard-fought compromise between
the European Parliament and the Commission, who wanted stronger
powers for the EU-level institutions and a transfer of direct
and mediation. Staff levels are expected to total 150, expected to rise to 300 within
four years. This pales in comparison to the budgets of national supervisors: the UK
FSA, in the budget period 2010/11, had a budget of more than GBP 470 m a year
and a staff of almost 3,300 (on an FTE basis); Germany‘s BaFin, in 2010, had a
staff of almost 2,000 and a budget of EUR 143 m.
11
Except for ESMA‘s aforementioned limited powers vis-à-vis CRAs.
Financial supervision in the EU
August 4, 2011 15
Review is scheduled and welcome
Pan-European supervision remains
desirable and necessary
supervisory powers over at least the largest financial institutions in
the EU to them, and (majority of) the Council, which wanted to
preserve the influence of national supervisors. As the heated
discussion about EBA‘s role in the latest round of European stresstests
has shown, this leaves the ESAs caught between high
expectations on the one hand and limited powers and head winds
from national supervisors on the other. As a result, the new structure
of micro-prudential supervision constitutes an uneasy arrangement:
If handled well, the integrated structure of national and EU-level
institutions could be tantamount to a pooling of the strengths of both
levels; it is at least equally likely, however, that conflicts over
competences will be frequent making supervision less effective.
Against this background it is more than appropriate that the EU
regulations establishing the ESFS stipulate that the entire structure
be reviewed after three years (i.e. at end-2013), and every three
years thereafter. This will provide an opportunity to assess whether
the new structure has made financial supervision in the EU more
efficient and more effective. In this context, the geographic
scattering of the ESAs across three locations should also come
under scrutiny, as it clearly impedes on the effectiveness of their
work. An effective integration with the work of the ESRB would
suggest that Frankfurt is the best choice for a joint location.
It is somewhat ironic that the recitals
12
in the ESA Regulations
actually explicitly recall the weaknesses and the limits of the
previous institutional structure based on the 3L3 – but then falls
short of really addressing these weaknesses by a bold step towards
pan-European supervision. We remain convinced that truly panEuropean
supervisory powers remain not only desirable, but
absolutely necessary. The financial crisis has demonstrated that the
co-existence of national supervision and integrated financial markets
is untenable. As has been observed, financial institutions ―live
globally, but die nationally‖. Hence, the choice is between either
preserving an integrated financial market in the EU and create a
corresponding EU-level supervisory framework for it, or to allow the
re-fragmentation of Europe‘s financial markets. Or to put it more
succinctly, quoting Lord Turner: ―We either need less Europe or
more Europe (…).”
13
The choice is clear.
Bernhard Speyer (+49-69-910-31735, bernhard.speyer@db.com)
12
Cf., e.g., recital 8: „The Union has reached the limits of what can be done with the
present status of the Committees of European Supervisors. The Union cannot
remain in a situation where there is no mechanism to ensure that national
supervisors arrive at the best possible supervisory decisions for cross-border
financial institutions; where there is insufficient cooperation and information
exchange between national supervisors; where joint action by national authorities
requires complicated arrangements to take account of the patchwork of regulatory
and supervisory requirements; where national solutions are most often the only
feasible option in responding to problems at the level of the Union, and where
different interpretations of the same legal text exist.
13
Adair Turner, FSA, at press conference on 9 February 2009.
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