A pan-European regulator will be here by 2010

The performance of EU national supervisors during the crisis, and in particular their refusal or inability to cooperate effectively, has been slated in influential reports, documents and speeches from de Larosière onwards – the February speech from the Chairman of CESR is a striking example.
 
The Commission’s adopted answer is to give enhanced powers to the three Lamfalussy Committees (CEBS, CESR and CEIOPS) to turn them from advisors into prudential supervisory authorities, whose decisions and guidance are binding on national supervisors throughout the EU.

Whilst the proposed timing for achieving implementation is unprecedented, what is even more interesting is the proposal to give the new Authorities direct responsibility for authorising and supervising two distinct types of entity with ‘pan-European reach’ – credit rating agencies and central clearing houses – particularly as it is unclear to us how Article 95 of the EC Treaty allows for direct supervision, rather than oversight.

Credit rating agencies and central clearing houses

The Commission has taken and extended this concept to encompass all ‘EU central counterparty clearing houses’ and at the same time narrowed the responsibility for regulation and supervision to the new European supervisory authorities. The proposal on rating agencies remains as stated by de Larosière, although without specifying new CESR (the European Securities Authority) as the supervisor.

Implications – supervisory oversight

The European Authorities will be far more involved in setting binding standards for supervisors, ruling on disagreements between them, ensuring much more uniformity of national implementation and interpretation of EU regulation through suppression of national differences; and will also be given direct decision-making powers relating to financial institutions in response to inaction or delay by national supervisors, or where urgent action is otherwise needed.

Implications – direct supervision

Firstly, it is an experiment with direct regulation at EU level, presumably based on the lack of requirement for rescue arrangements for either type of institution, and consequently the appearance that there is no national taxpayer exposure driving a national interest in regulation, even when the entity is incorporated or established within a member state.

On that basis, the European Supervisory Authorities (ESAs) can theoretically take on the authorisation and supervision of systemically important entities without coming into conflict with national supervisors (or breaking European law).

Secondly, it implies that the ESAs will be setting up their own authorisation and supervision functions and carrying out those functions directly themselves (perhaps on the basis of secondment from national supervisors). The Commission suggests ESA activities could include on-site inspection and investigation - which must then also require an enforcement mechanism for effective action and sanctions against individual entities.

This creates a full service, centralised EU financial services supervisor, albeit with only a small flock of directly regulated entities – for the time being.

Thirdly, the contrast between credit rating agencies and clearing houses is stark, but illuminating: from a supervisory risk management perspective, whilst both types of entity will be subject to systems and controls regulation, supervising credit rating agencies is then about conduct and management of conflicts of interest, whereas supervising clearing houses is about prudential exposure management and the processing of huge volumes of cash and securities. Consequently, the ESAs should rapidly gather exposure and experience in supervising both prudential and conduct risks, within a small but systemically important population of directly regulated institutions.

The future?

The ESA’s will then be supervising entities according to standards that they have also introduced and enforced at member state level, and the prospect of regulatory arbitrage also disappears.

From the perspective of regulated financial institutions, this feels quite attractive – absolutely consistent requirements and supervisory approach, irrespective of the Member States in which the institution is incorporated or operating.

The key question, if this construct is valid, is what happens to legal, taxation and insolvency differences based on the domicile of the institution? Whilst that looks like an irreconcilable question for the time being, the rate of global political and economic change based on an almost unprecedented global shock to the financial system and macro-economy means things may look very, very different in five years time.