Institute of Law European Financial Supervisory System International

Institute of Law European Financial Supervisory System International and European Financial Law – Lecture 2 Prof. Dr. iur. Kern Alexander 09. 03. 2021 Page 1

Institute of Law L 1 L 2 L 3 L 4 International Law in Financial Markets European Financial Supervisory System EU Capital Markets Market Abuse, Insider Dealing and Market Manipulation L 5 EU Banking Law L 6 EU Monetary Law L 7 Mi. FID L 8 The Organization of Clearing and Settlement in Securities Trading L 9 International Monetary Law L 10 UK and Swiss Financial Regulation Reform L 11 Wholesale Capital Markets L 12 Rebuilding International Financial and 09. 03. 2021 Page 2 European Law

Institute of Law Lessons from the crisis • Systemic risk arises from institutions and market structures – • • Power of financial contagion in liberalised EU & global financial markets Policy analysis – Market-based financial regulatory models do not adequately monitor and control systemic risks – Cross-border macro-prudential supervision & regulation required Policy implementation – Outdated Home country supervision exacerbated externalities – Redesigned EU institutional structures to monitor and control effectively cross-border externalities 09. 03. 2021 Page 3

Institute of Law Principles of EU Institutional Design • Supra-nationalism v. inter-governmentalism • Institutional balance (Meroni) – separation of powers v. interest representation • EU constitutional law principles – legality, due process, proportionality, equal treatment & legitimate expectations • EU administrative law – technocratic autonomy based on supranational regime that depends for its democratic legitimacy on national structures of hierarchical government. • Governance - the phenomenon of ‘governance without government’ Commission’s White Paper on governance 09. 03. 2021 Page 4

Institute of Law Changing market structures and global financial firms • Risk management & financial innovation: Technical developments in data analysis capability, in statistical theory and in theory of finance have transformed risk management, pricing, and the range of financial products. • Global financial firms: risk management, strategy, Treasury function and audit centralised at group level • Financial regulation and crisis management have not kept pace with these changes. 09. 03. 2021 Page 5

Institute of Law Modern financial regulation has evolved to an interactive risk-based process • International Ø Basel II (III) - (I) devise a process to measure financial risk, and (II) devise corporate governance structure to meet home/host regulatory approval • Europe Ø Home country control, mutual recognition, minimum standards – However, a trend towards interactive regulation (ie. , MIFID) Ø Solvency II – risk-based process based on models Regulation has become a source of innovation and competitive advantage 09. 03. 2021 Page 6

Institute of Law EU financial legislation & policy – some history Ø Pre-1986 – unsuccessful efforts to approximate and make equivalent financial law and regulation across EU states Ø 1985 White paper and 1986 Single European Act Home country control, mutual recognition based on minimum standards – the EC passport Ø EU legislation is a tool for liberalisation with little oversight of member state regulatory practices Ø Lisbon Council Decision (post 2001)– FSAP & Lamfalussy: Harmonisation of laws and coordinated regulatory practices based on market-based models (Mc. Creevy era) 09. 03. 2021 Page 7

Institute of Law EU FSAP – critique pre-crisis Ø Level playing field and competition concerns Greater consistency between directives, flexible legislation that adapts to markets, linguistic issues for implementation, EU regulations v. directives, avoid unintended consequences and not undermined by subsequently adopted national laws (Lord Woolf, June 2005). Ø Greater uniformity needed in application and implementation of EC financial law 09. 03. 2021 Page 8

Institute of Law The EU Lamfalussy structure Council Commission Parliament L 1 L 2 L 3 L 4 Legislation EBC¹ EIOPC¹ ESC¹ Implementing details CEBS² CEIOPS³ CESR³ Convergence Enforcement Commission EBC = European Banking Committee EIOPC = European Insurance and Occupational Pensions Committee ESC = European Securities Committee FCC = Financial Conglomerates Committee CEIOPS = Committee of European Insurance and Occupational Pensions Supervisors CESR = Committee of European Securities Regulators 09. 03. 2021 FCC¹ ¹ Finance ministries ² Supervisors and Central Banks ³ Supervisors Page 9

Institute of Law Critique of the Lamfalussy system (2007 -09) • Patchy progress by L 3 committees in promoting consistent implementation of Community legislation/enhancement of convergence in EU supervisory practices • Weak link (IMF 2007): no clear framework with respect to the oversight of the cross-border operations of financial groups in EU • Refinements – eg Mo. Us, CEBS/BSC Joint Task Force on Crisis Management; strengthening of L 3 committees • Van den Burg and Daianu report – EP 2008 09. 03. 2021 Page 10

Institute of Law Van den Burg and Daianu report – EP 2008 • • • Strengthen and clarify status of Lamfalussy 3 Level 3 committees. Promote supervisory convergence and level playing field 3 Level 3 committees should be able to take decisions based on QMV and adopt common rulebook Oversee supervisory colleges and interface with international bodies EU supervisory system with legal competence to monitor crossborder banks and link micro & macro supervision Commission to propose regulations by late 2009 09. 03. 2021 Page 11

Institute of Law The future EU financial architecture: linking microprudential and macro-prudential supervision From De Larosière Report to the EU Commission proposed Regulations. • On the micro-prudential side: the European System of Financial Supervisors (ESFS). q It will consist in the current Level 3 Committees of supervisors, which will be transformed into new European Supervisory Authorities (ESAs) responsible for banking, insurance and securities respectively. • On the macroprudential side, a European Systemic Risk Board (ESRB) will be established. q It will be composed of EU central bank governors, including the ECB President, the chairpersons of the ESAs, a representative the European Commission, as well as representatives of national supervisory authorities and the Chair of the EFC (the latter two categories without voting rights). 09. 03. 2021 Page 12

Institute of Law European System of Financial Supervision European Systemic Risk Board (ESRB) [Chair elected by ESRB Board] Macro-prudential supervision Members of ECB/ESCB General Council (with alternatives where necessary + Chairs of EBA, EIOPA & ESMA Information on micro-prudential development European Commission + Early risk warning European Supervisory Authorities (ESAs) Micro-prudential supervision 09. 03. 2021 European Banking Authority (EBA) European Insurance Occupational Pension Authority (EIOPA) National Banking Supervisors National Insurance Supervisors European Securities & Markets Authority (ESMA) National Securities Supervisors Page 13

Institute of Law ESFS • European Systemic Risk Board (ESRB) • European Banking Authority (EBA) • European Securities and Markets Authority (ESMA) • European Insurance, Occupational and Pensions Authority (EIOPA) • The Joint Committee of the European Supervisory Authorities (Joint Committee) • The competent authorities in the Member States 09. 03. 2021 Page 14

Institute of Law Legal basis • Article 114 as the legal basis for the establishment of bodies that are vested with responsibilities for contributing to the harmonisation process and facilitating uniform implementation by MSs (Case C-66/04, C-217/04) – Actually and objectively apparent from the legal act creating the body in question that its purpose is to improve the conditions for the establishment and functioning of the internal market – Tasks conferred on such a body must be closely linked to the subject -matter of the relevant harmonizing legislation 09. 03. 2021 Page 15

Institute of Law The ESFS: subsidiarity and proportionality • “[T]he objective of this Regulation, namely an effective macro- prudential oversight of the Union financial system, cannot be sufficiently achieved by the Member States because of the integration of the European financial markets, and can therefore be better achieved at Union level, the Union may adopt measures in accordance with the principle of subsidiarity, ”. . . [and] “in accordance with the principle of proportionality, ”. . . “this Regulation does not go beyond what is necessary to achieve that objective. ” (ESRB Regulation, rec 20) • Justified in cost-benefit terms? • Subsidiarity as a basis for managing relations between ESFS/ESRB/ESAs and MS systemic risk oversight bodies & supervisors 09. 03. 2021 Page 16

Institute of Law ESAs (I) • Chairperson (strategic leadership and reports to EP and other stakeholders) has ‘proven supervisory experience’ • Board of Supervisors (Chairperson presides) • Management Board (Chair presides) • Executive Director (oversee all aspects of daily management, shape admin processes and prepare work programme and budgets and supports Chair) 09. 03. 2021 Page 17

Institute of Law ESAs (II) • Ensuring that a single set of harmonised rules and consistent supervisory practices are applied by national supervisors; • Ensuring a common supervisory culture and consistent supervisory practices; • Collecting micro-prudential information; • Ensuring consistent application of EU rules, and resolving disputes in cases such as the manifest breach of EU law or ESA standards and disagreement between national supervisors or within a college of supervisors 09. 03. 2021 Page 18

Institute of Law The ESFS: subsidiarity and proportionality • “[T]he objective of this Regulation, namely an effective macro- prudential oversight of the Union financial system, cannot be sufficiently achieved by the Member States because of the integration of the European financial markets, and can therefore be better achieved at Union level, the Union may adopt measures in accordance with the principle of subsidiarity, ”. . . [and] “in accordance with the principle of proportionality, ”. . . “this Regulation does not go beyond what is necessary to achieve that objective. ” (ESRB Regulation, rec 20) • Justified in cost-benefit terms? • Subsidiarity as a basis for managing relations between ESFS/ESRB/ESAs and MS systemic risk oversight bodies & supervisors 09. 03. 2021 Page 19

Institute of Law Harmonised code and technical standards norm generation (I) • ESAs devise code & standards in areas specified by directives (delegation) • No general mandate to devise code/standards • Level 1 – Directives/Regulations provide Principles Level 2 – Delegated acts may involve Council/EP Level 3 – ESAs deliberate and adopt code/standards by QMV, and then Commission decides to endorse and can amend or substitute new code rules & standards. Council/EP may object, resulting in a review whereby the Commission may decide against ESAs. Only ESAs and Commission adopt acts for technical implementation 09. 03. 2021 Page 20

Institute of Law Harmonised code and technical standards norm generation (II) • Level 4 – Decentralised implementation & enforcement by MSs • ESA regulatory technical standards will be legally binding • Direct application as law in all EU states 09. 03. 2021 Page 21

Institute of Law ESA code/standards – the effects • EU regulatory rulebook addressed to national supervisors and displaces national rulebooks • Applies directly to banks/firms/individuals • Can be invoked to regulate relationships between firms – ie. , make some contracts illegal and provide a basis for injured parties to recover damages in MS courts • Technical standards/requirements & risk measurement process delegated to ESAs, and information exchange among supervisors 09. 03. 2021 Page 22

Institute of Law Fiscal autonomy • ESAs not allowed to take any measures under that would require a MS to make fiscal expenditures 09. 03. 2021 Page 23

Institute of Law ESAs – the implications? • Will ESAs undermine effectiveness of decentralised member state supervision? • What is the optimal institutional design for EU regulation/supervision: a single EU supervisor? • Do the different polities and regulatory cultures across Europe make harmonised codes, standards and technical guidance impractical in today’s risk-based supervision? 09. 03. 2021 Page 24

Institute of Law How will harmonised norms work for macroprudential regulation? Firm level Ø Counter-cyclical capital & dynamic provisioning linked to points in the business cycle Ø Liquidity requirements – wholesale funding limits Ø Leverage caps – non risk-based limits on credit growth System level Ø Ø Monetary policy – expand focus to include asset prices Trade policy and capital controls Aggregate levels of leverage in the system (ie. , credit quotas) The role of Lender of Last Resort (its scope of application) 09. 03. 2021 Page 25

Institute of Law Conclusion • Increasingly integrated EU financial markets • Centralised governance and risk management of largest 50 or so EU financial institutions • Is the existing home/host/Lamfalussy adequate? • ESA powers to generate norms directly to member states • What are the implications? A EU single supervisor? • Far reaching re-appraisal of the role of EU financial regulation: developing uniform rules, technical standards and guidelines to enhance the implementation of micro-prudential regulation and macro-prudential supervision 09. 03. 2021 Page 26

Institute of Law The regulator’s task ‘the art of progress is to preserve order amid change, and to preserve change amid order’ Alfred North Whitehead 09. 03. 2021 Page 27

Institute of Law Further readings – EP Reports • Alexander, K. ‘Which future model for Europe? ’ (Feb 2010, IPA CRIS) • Alexander, J. Eatwell, A. Persaud & R. Reoch, Financial supervision and crisis management in the EU’ (Dec. 2007) http: //www. europarl. europa. eu/activities/committees/studies/download. do ? language=en&file=26588 • ‘Clearing and Settlement in the EU’ K. Alexander, J. Eatwell, A. Persaud and R. Reoch (Sept. 2009) IPA ECON 2009/001. http: //www. europarl. europa. eu/activities/committees/studies/search. Perfor m. do? page=2&language=EN 09. 03. 2021 Page 28