Structure of regulation set up by the European Union

The basis of the stability of the European financial system is the equality and mutual recognition of supervisions. This is accomplished by the principle of home-country control, which is a guideline for the definition of the organization responsible for the prudential supervision of financial service providers operating in several countries. Part of the common framework involves directives with com-pulsory force, which are accepted and inaugurated by the Ecofin meeting, con-sisting of financial ministers of the EU with the help of international professional organizations. Subsequently, the harmonization and acceptance of directives in the individual countries is the responsibility of finance ministers. Thus, the national authorities do have some room for manoeuvre to highlight the differences in inter-pretation of directives in their own legislation. This, however, offers the possibility for market players to make use of the regulatory arbitrage due to differences, while it may hurt the conditions of the emergence of real competition.

Several types of framework systems and agreements serve the practical develop-ment of the consolidated and comprehensive supervision system. From among these, the most important ones are the bilateral agreements between national supervisions (Memoranda of Understanding), which are required by the stipula-tions on the principle of home-country control and on the consolidated supervi-sion.¹⁸However, these agreements are elaborated in the most detailed way in the case of institutions supervising the banking sector.

To support the cooperation and exchange of information of supervisory authorities between each other and central banks several forums have been established, for the time being only in a sectoral breakdown. The forum of professionals of bank-ing regulation for discussing the position of individual institutions and scope of problems is the Groupe de Contact. The Banking Supervision Committee was established to support the ESCB in decision-making, which aims at the stability of the banking and financial system – first of all problems of the payment systems and liquidity crises. Obviously, this organization is also contributing to the internation-al trade of information and cooperation. The exchange of information of the

insur-18However, there are also agreements with organizations outside the compulsory scope and with organ-izations outside the EU, for example with the US FED and the Office of the Comptroller of the Currency, and the supervisory authorities of Canada and Switzerland.

ance supervisions is made within the framework of the Conference of Insurance Supervision Authorities of the Member States of the European Union, briefly the Conference. Conciliation forums of securities supervisions are the European Securities Committee and the Committee of European Securities Regulators (CESR).

The European Commission aimed at the development and regulation of the unified European financial market when the Financial Services Action Plan was formulat-ed. On the basis of the Action Plan the Financial Services Policy Group was set up in 1999, with the responsibility of defining the priorities of cross-sector regulation.

The Mixed Technical Group on the Prudential Supervision of Financial Conglomerates (MTG) was created especially to prepare the regulation of con-glomerates, which, following the acceptance of the related directive, became the forum of further cross-sector technical conciliation. A wide range of institutions took part in the outlining of the directive, among them the Banking Advisory Committee, Insurance Committee and High Level Securities Supervisors Committee, with the representation of finance ministers, national supervisory authorities and central banks.

For the principles, structure and organization of regulating financial groups in the European Union and the planned directive on the supplementary supervision of financial conglomerates see chapter 4.

3.4.2.1. The new supervisory framework of FSA

The British integrated financial supervisory authority, the Financial Services Authority (FSA), responding to the new tendencies in the financial markets and, with special attention to the high level protection of clients and marketsand the complexity and costs of reporting obligations, elaborated a new type of supervi-sory framework. The regulatory structure created with the active cooperation of market actors was presented to the professional community in 2001. The planned date of inauguration of the final version is 1 January 2004.

The most important innovation of the framework is that instead of investigating institutions in the usual way, on a sectoral basis, they will supervise them on a risk basis. Thus the representatives of different sectors will be rated on identical

prin-ciples regarding credit, market, operational, insurance and liquidity risks, but the group level risk will also be specially highlighted. The same integrated approach appears in the prescriptions regarding the measurement of risks, the methods of risk management and the calculation of the available amount of capital.¹⁹ The other dimension in the categorization of individual institutionsis the potential loss in client’s assets due to possible failures, and the extent of loss in market con-fidence. The three categories of institutions separated on this basis – abandoning the sectoral approach again – arebroken down by the risk exposure of clients’ assets.

In the course of the elaboration of supervisory principles, relevant EU directivesin force in June 2001 and the recommendations of international professional organ-izationswere taken as a basis. Nevertheless, the expectations formulated in these principles were exceeded several times.This happened in cases where the mini-mum requirements formulated were not sufficient to accomplish supervisory goals.

In the field of consolidated supervision the following additional expectations emerged:

– Consolidated supervision should cover all types of investment companies – Expectations of group level supervision should include financial conglomerates.

The FSA considered the prudential regulation both of homogenous (inter-sectoral) and heterogeneous (relating several sectors) groups. It plans to introduce a unified, consolidated capital adequacy method inspiring efficient capital allocation for the homogenous groups. In this sense intra-group transactions and capital allocations will be exempted from the capital adequacy calculation applying to the group as a whole. As an innovation, in order to facilitate consolidation proxy prescriptionswill be introduced for the non-regulated group members.

In the regulation of heterogeneous groups the anomaly in the EU directives, effec-tive in 2001, was bridged over, namely, in the regulation of insurance companies neither banks, nor investment companies were recognized as financial institutions and vice-versa. Thus, according to the rules of the FSA, if any representatives of the above-mentioned three sectors form a group, they are subject to a unified cal-culation method of aggregating and capital requirement. Thus the dangers of a double gearing and excessive leverage in holdings operating in more than one sec-tor is avoided. The calculation of the group-level capital requirement is made by

19Nevertheless, cross-sector conciliation still does not turn up in the capital adequacy regulations.

summarizing individual capital requirements of the group members, taking into consideration the values of cross-ownership. Excessive capital over and above the capital elements mutually accepted will be available for group-members with cap-ital shortage. With this, regulators hope that a real picture will evolve regarding the capital position on the group level, while at the same time acknowledging the indi-vidual members’ capital adequacy.

3.4.3. Response of the US regulators to the challenge of financial