Giving Europe a single voice

The agreement reached among the three branches of the European legislature – Commission, Council and Parliament – can rightly be called a historical one. It consists of creating a new model of regulation for the three segments of financial activity, ie banking, insurance and securities markets.

Three authorities will effectively streamline the different regulatory system in the 27 member states’ European Union. It puts an end to decades of discussions and hesitations, and will allow Europe finally to speak with one voice – at home and further afield – on regulatory matters.

The process leading to the new structure was finalised in record time. It started in February 2009 with the seminal report from Jacques de Larosière, formerly IMF director general and governor of France’s central bank. Two basic concepts lay at its centre: systemic risk has to be addressed Europewide, and Europe’s supervisory structure must be more effective.

On the first point, a European Systemic Risk Board, composed of central bankers and the head of the supervisory authorities, will be in charge of identifying systemic developments, addressing recommendations and warnings to national supervisors.

The ESRB will fill a widely recognised gap, ensuring macro-prudential developments are systematically addressed and drawn to the attention of supervisors in their jurisdictions. Although not legally binding, these decisions would be “morally binding” on an “act or explain” basis.

After lengthy negotiations, an agreement was found on the European system of financial supervision. Although rulemaking will be more centralised, day-to-day supervision will remain predominantly a national competence. Europe’s wide diversity does not allow all supervisory matters to be dealt with by one single institution and the subsidiarity principle leads to strong involvement of domestic supervision.

But more coordination at the level of rulemaking and national actions will be pursued by the new authorities. The rulemaking power of the authorities – to be exercised with the agreement of the Commission – will allow the development of uniform regulations applicable in all states, through a European “rulebook”. This will considerably facilitate cross border offering of services, as the applicable rules will be identical in all jurisdictions.

Products offered from abroad will be subject to the same safety standards and investor protection rules as applicable in the domestic context. Over time one can expect more subjects will be taken up by the authority, creating a uniform regulatory system comparable to the US pattern, where SEC or Fed rules are applicable in all member states.

Equally important is the power to ensure the actual implementation of the rules will be identical, allowing the authorities to investigate not only the national rulebook but also actual practice. In case the European regulations are not applied, the authority will be able to urge the national supervisors to adapt.

The creation of these new authorities is the first step towards a larger movement: their competences still have to be determined in the different directives and regulations. Initially, their field of action will be modest, but over time, and with the increasing complexity of financial regulation, it is inevitable that a wide range of detailed regulatory instruments will have to be developed.

One sees already wide ranges of issues – in the regulations of directives on credit rating agencies, Ucits, alternative investment fund managers, derivatives and short selling - being proposed for action to be undertaken by the authorities.

The European regulatory model will continue to be based on the input of the national supervisors. Future action will not be based on a top-down approach, as is typical for a centralised supervisory authority, but expresses the cooperative basis of the system. Wide consultations with all market participants – both sell and buy side – will continue to be practiced.

The new structures pose several questions: why have the three business lines not merged into one single authority? Or even as was proposed by a French Member of Parliament, transferred to Frankfurt, close to the ECB? Why has there been no autonomous rulemaking power?

Merging the authorities might have resulted in a nice political beauty contest, but in the urgency of the crisis, cannot be a priority. And more powers would have required a Treaty change, according to European law specialists.

In the long-term, this decision will be the starting point for better regulation in Europe, more transparent, more uniform, more efficient and above all offering more protection to investors. In that sense it should be a welcome signal of confidence and hope in the ongoing financial crisis.

CESR has been chaired by Eddy Wymeersch since February 2007. Since drawing up this blueprint, he has been succeeded by Carlos Tavares, formerly vice chair of CESR.