June 22, 2009
"What do we want?" "Gradual Change!"; "When do we want it?" "In due course." So goes the apocryphal English protest cry. There is nothing gradual about the proposals afoot to centralise policy-making on prudential supervision of financial firms at an EU level. Firms doing business in the EU and, in particular, in London, would do well to keep a careful eye on regulatory developments.
The latest centralising push came at the meeting of the European Council on 19 June 2009. The agreed Presidency conclusions include commitments on the following:
- continued progress on the regulation of alternative investment funds[1]
- further work on countering the pro-cyclical effect of regulatory standards
- "rapid action" on executive pay and remuneration
The Council has also agreed a further round of EU institution-building, endorsing the creation of:
- a European Systemic Risk Board, to monitor and assess threats to financial stability
- a European System of Financial Supervisors ("ESFS"), comprised of three new European level supervisory authorities: a European Banking Authority, a European Insurance and Occupational Pensions Authority and a European Securities Authority
The New Regulators
The proposed European Systemic Risk Board‘s ("ESRB") stated function is to prevent the re-occurrence of European-wide financial crisis. It is to achieve this goal by establishing macro- and micro- prudential supervision accompanied by the issuance of early warnings of threats to financial stability. The ESRB will also set out recommendations for action and monitor their implementation. A further international element is envisioned for the ESRB including liaison with the International Monetary Fund, the Financial Stability Bard and third party counterparts to combat issues on a global level.
Warning and recommendations are anticipated to be either general in nature (whole market observations) or they may be aimed at individual Member States requiring a specific policy response. As the board will not to be provided with any legally binding powers its ability to enforce recommendations will lie in pressure for Member States to abide by the recommendations against the risk of having to publicly justify a failure to do so. In line with the lack of legal powers the ESRB will not have any direct crisis management responsibilities.
By contrast, each of the new pan-European Financial Supervisors will have its own legal personality, replacing the existing Committees of Supervisors with increased sector specific responsibilities, defined legal powers and greater authority.
One of the key roles of the ESFS will be the creation of a single set of harmonized rules (a "single rulebook") for supervision of each financial sector across the Member States. For those on the front line charged with interpreting the intent of EU legislators, this will surely be a mixed blessing. Meanwhile, the day to day monitoring of common supervisory requirements and technical standards will remain with national regulators.
Each authority will also provide interpretative guidelines and facilitate dialogue for joint agreement where national supervisors disagree on supervisory actions or principles. Where necessary the authority will have the power to decide the matter.
It is suggested that the authorities will be able to take decisions on issues concerning capital allocation between parent and subsidiary entities. However, recognising the political realities that flow from the use of an individual nation’s taxpayer funds in bailouts, their powers will not extend to decisions regarding rescues and protection of savers’ deposits.
The regulators will have teeth however. It is proposed that ESFS could involve the Commission to adopt a "decision" where there has been a "manifest breach of Community law" to require a national supervisory authority to take a specific action or to refrain from taking action and thereby come into compliance.
The authorities will also be given specific responsibilities for supervision of certain pan-European entities, such as credit rating agencies and it is proposed that competency may extend to the prudential assessment of European mergers and acquisitions in the financial sector.
UK Concessions
As is customary at such events, the UK attended the Council with various goals (and countervailing "concessions") in mind. The most important agreement achieved by UK and its allies was to secure the insertion into the final text of an acknowledgement that "recognising the potential liabilities that may be involved for Member States, decisions … shall not directly impinge on the fiscal responsibilities of the Member States." Behind this coded language is an understanding that the taxpayer of one Member State will not be called upon to bail out the spendthrift institutions of another.
Analysis
The perception that the financial crisis had its roots in "Anglo-Saxon" financial innovation and over-lending has now given a fillip to EU centralisers who have the excuse they need to secure new territory over which to exert EU competency. Certainly there is a need to address the pro-cyclicality inherent in Basel I/II and to look afresh at the particular challenges posed by the failure of financial institutions operating cross-border (witness the state-to-state tensions over the Icelandic bank collapses, Irish deposit guarantees and the collapse of Fortis). However there is a real risk that in the rush to regulate, unnecessary harm will be done to an important sector of the European (and, in particular, the UK) economy. It is unclear, for example, how a "single European rulebook" would have prevented the financial crisis just witnessed.
Rather, what is needed is regulators (existing or new) and central bankers brave enough and willing to take the punchbowl away from the party and politicians brave enough to allow them to do it.
With so many financial institutions operating across borders (and not just EU borders), we hope that the EU will be coordinating its efforts with the Obama administration, together with other interested parties such as the IMF. We will be working with clients and other stakeholders to assess the detail of proposals as they come forward.
The Commission is inviting reaction to its proposals, to be received by 15 July 2009. If you would like information on how to respond, please contact the author of this article.
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[1] See the Gibson Dunn client update The European Commission Heads Off the "Trojan Horse" – Proposed New Regulation of Investment Funds issued on May 1, 2009.
Gibson, Dunn & Crutcher LLP lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work or James Barabas (+44 20 7071 4253, [email protected]) or Selina Sagayam (+44 20 7071 4263, [email protected]) in the firm’s London office.
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