Karel lannoo Chief Executive Officer, CEPS
The post-crisis financial market agenda
The EU is in the midst of a fundamental institutional and regulatory overhaul in response to the financial crisis. This process is primarily driven by domestic agendas, but G20 commit-ments also come into play. Following the de Larosière report, the Council acted rapidly with the endorsement of the new institutional structure in December 2009, as proposed by the European Commission. after adoption by the European Parliament, the main task ahead is to make the new structure work. On the regulatory side, a huge agenda lies ahead, covering the upgrade of prudential, conduct of business and product rules. Many decisions await the incoming European Commission, although the EU Council of finance ministers has already taken a clear line. a tight coordination with the G20 in general and the US in particular is needed to counter concerns in the financial sector about regulatory overkill and an uneven playing field.
In addition, market mechanisms must be respected and, as much as possible, stimulated.
The de Larosière follow-up
The new structure brings a sea change in financial supervision in the EU. at the top is the European Systemic Risk Board (ESRB), which will give general risk warnings and recom-mendations on specific risks. It will specify the procedures to be followed by the European Supervisory authorities (ESa) to act upon its recommendations. The ESas will have the powers to enact standards and to control their implementation. They will ensure large cross-border financial groups are adequately supervised through their participation in supervisory colleges. all new legislative measures are regulations, hence they will be directly applicable, and do not need to be transposed into national law. a political agreement on the different measures was reached in the EU Council in December 2009 under the Swedish Presidency.
The readings by the European Parliament are not expected to change the proposals much, as the legislature is largely in favour of the new structure.
The ESRB will only be consultative, but is supposed to derive its authority from its reputation and expertise. It will be run by the European Central Bank (ECB) and largely composed of EU
central bankers, with limited participation of the supervisors, and only one representative of the Council of EU finance ministers. The ESas on the other hand will have legal personality, and the power to impose binding agreements to effectively coordinate supervision of cross-border groups and structures. However, such decisions may not impinge upon the fiscal responsibili-ties of the member states, hence the fact that the powers to liquidate a cross-border bank will remain at the home-country level, in cooperation with the respective host countries.
The changes which are being discussed in the US (House act of 11 December 2009) are different from the EU in that they leave the powers at the macro-prudential level largely with the Secretary of the Treasury, who will chair the Financial Services Oversight Council (FSOC), which brings together the different supervisory authorities and the Federal Reserve. On the micro-prudential side, the institutional changes in the US comprise the merger of the two banking supervisory authorities OCC (Options Clearing Corporation) and OTS (Office of Third Supervision), and the creation of a federal insurance authority and a consumer financial pro-tection agency. They stop short, at least for the moment, of going towards a more radical restructuring.
The main challenge for the EU is to make the new structures work. This task is for the ESRB more of a conceptual nature: what are macro-prudential risks, and how will it act once these risks have been identified? For the ESas, the challenge is more of an operational and organi-sational nature: how to cope with the enormous workload ahead. EU policy makers will have to monitor whether the job division between the ESRB and ESas is clear-cut, and eventual-ly intervene to clarify the distinction between macro and micro-prudential supervision. as for the ESas, policy makers will need to further clarify their tasks: what is a single rulebook, and how will this be enacted? What will be the division of responsibilities between the EU Commission and the ESas in the enforcement of rules? Will member states accept formal mediation between supervisors by the ESas? a prioritisation in the workload of the ESas by the EU Council Presidencies and Commission will thus be welcome.
The regulatory agenda
The agenda for the incoming Barroso II Commission has already been set, but many decisions need to be taken. The crisis revealed important shortcomings in the regulatory framework, to the extent that a core principle of the single market, the single passport and home country control, was called into question. To restore this principle, the European Commission will have to engage in moving towards a much higher degree of harmonisation in certain areas – a more European approach and less reliance on member state systems – and stricter enforce-ment. The workload could be subdivided into:
Prudential rules
• : further modifications to the capital requirements directive, as further to the December 2009 proposals of the Basel Committee; further harmonisation of deposit protection schemes or the creation of an EU-wide fund; prudential rules for clearing and settlement systems;
Product rules:
• more harmonisation of financial products, i.e. hedge funds (alternative investment funds), mortgage loans; an EU regime for retail investment products;
Conduct rules:
• stricter rules for transactions in certain products, such as OTC deriv-atives; better control of transparency and equality of access to securities markets;
tighter penalisation of market abuse; remuneration rules.
Following the EU’s 1993 deposit protection directive, three different schemes of protection co-exist: the protection offered by the home country (applicable to the head offices and its branches or through free provision of services), the protection offered the host country (where the bank is a subsidiary of a foreign bank) and the home country scheme ‘topped up’ with the level offered by the host country (where the level of protection for a branch operating in the host country is lower than that of its home country). Until the crisis broke out, an overwhelming majority of consumers was not aware of the consequential differences in protection schemes.
In the midst of the crisis, the member states provisionally agreed in the EU Council to increase the minimum levels to €50,000, but did not change the basics of the 1993 EU directive, nor the method of funding or the statute of the national deposit protection schemes. The European Commission will need to decide soon in the second Barroso Commission on how to reform the system for the long-term. In the interest of the single market, it will need to decide to create a European-wide fund, analogous to the Federal Deposit Insurance Corporation of the US, but this will undoubtedly lead to acrimonious discussions with the member states.
Other elements will need to be reformed to get consumers back on board of the single market.
Mortgage lending, for example, is not subject to any degree of EU harmonisation, whereas (short-term) consumer lending is. although mortgage lending is about 9 times more important than other forms of consumer credit, a consultation in 2007 concluded that the different forms of national legislation seemed to work well enough, and that there was no immediate need for European harmonisation. However, principles such as responsible lending and loan-to-value ratios could well be harmonised and enforced at European level, as lax mortgage lending standards in one member state have European-wide implications.
a related priority for the incoming European Commission is to continue to stimulate self-reg-ulation. The principle may have been discredited in the crisis, but it is an illusion to believe that everything can be regulated and controlled by public authorities. Strengthening the role and clout of standard setters and self-regulatory organisations is a part of a well-functioning enforcement system.
apart from the regulatory agenda, the Barroso II Commission will also have to continue the work of applying the EU’s state aid rules to the financial sector. This work led to the first results in November 2009, with the first Commission decisions on state-aided banks, such as ING and KBC, but many more are in the pipeline. It will be important to examine how the Commission will enforce the Treaty rules to maintain an integrated financial market, and which principles will be applied.