Financial market supervision: European perspectives.(Congressional Research Service)(Report)

 Contents  Overview The European Union Financial Crisis    Other Major EU Financial Directives       Investment Services Directive       Financial Services Action Plan       Markets in Financial Instruments Directive       Capital Requirements Directive    EU Financial Supervisory Authorities    The "European Framework for Action"    The de Larosiere Report and the European Plan for Recovery       The de Larosiere Report       Driving European Recovery Conclusions Appendixes Appendix. Summary of Recommendations of the de Larosiere Report on EU  Financial Market Supervision 

February 4, 2010

Summary

The global financial crisis has sparked a debate over the cause and impact of the crisis. Academics and policymakers are searching for changes in the financial system that can correct any perceived weaknesses in the structure of regulation, the content of regulations, and the coverage of financial instruments and activities. Since the onset of the crisis, numerous proposals have been advanced to reform or amend the current financial system to help restore economic growth. In the United States, the Obama Administration has proposed a plan to overhaul supervision of the U.S. financial services sector. The proposal would give new authority to the Federal Reserve, create a new Financial Services Oversight Council, create a Consumer Financial Protection Agency, and create a new National Bank Supervisor to replace the Office of the Comptroller of the Currency and the Office of Thrift Supervision. In contrast, Senator Collins introduced S. 664, the Financial System Stabilization and Reform Act of 2009, with a companion measure, H.R. 1754, that was introduced by Representative Castle in the House of Representatives. The measures would create a Financial Stability Council and grant the Federal Reserve the authority to examine the soundness and safety of the financial system posed by bank holding companies. Other measures include: S. 1682 (Senator Cantwell), the Derivatives Market Manipulation Prevention Act of 2009; S. 1803 (Senator Merkley), the Federal Reserve Accountability Act of 2009; S. 2756 (Senator Warner) the Financial Services Systemic Risk Oversight Council Act of 2009; H.R. 3795 (Representative Frank), the Over-the-Counter Derivatives Markets Acts of 2009; H.R. 3968 (Representative Ellison), to amend the Bank Holding Company Act; and H.R. 3996 (Frank), to improve financial stability. The crisis has underscored the fact that national and international financial markets have become highly integrated, and problems in one market can trigger contagion that can spread both among countries and into economic sectors to affect businesses, employment, and household well being.

Similarly, governments in Europe are considering what, if any, changes they should make to their national financial systems. Along with the United States and other countries, European countries also are considering changes to the international systems of financial supervision and regulation in order to ensure prosperity through the smooth operation of domestic and international financial systems. This process may include reconsidering the roles and responsibility of the central banks in the post-financial crisis era. Various organizations and groups are advancing a large number of recommendations and prescriptions. Some goals for any such adjustments may include providing an institutional structure for oversight and regulation that is robust, comprehensive, flexible, and politically feasible while providing appropriate incentive structures to preclude excessive risk-taking. Of course, there are no guarantees that amending the current system or employing a different regulatory and supervisory structure will preclude a repeat of the most recent financial crisis given that financial markets and institutions are continually growing, innovating, and responding to government- and market-imposed constraints.

This report addresses the European perspectives on a number of proposals that are being advanced for financial oversight and regulation in Europe. The European experience may be instructive because financial markets in Europe are well developed, European firms often are competitors of U.S. firms, and European governments have faced severe problems of integration and consistency across the various financial structures that exist in Europe.

Overview

The global financial crisis has resulted in huge losses in wealth, jobs, and economic activity. In some cases, it has led to public demonstrations and to changes in national governments. Academics and policymakers generally agree that the financial system can benefit from additional supervision or regulation that addresses issues of systemic risk. Such efforts, however, likely will require hard, and possibly politically unpopular, decisions concerning the supervision and regulation of domestic financial markets and new layers of international coordination that could challenge entrenched national interests. Furthermore, there are no metrics for gauging whether such measures are a prescription for curing the current crisis or are a policy framework for preventing the next crisis, since financial markets are constantly innovating and responding to regulation and oversight. In addition, there are no models of market oversight or supervision that have proven to be clearly superior. In the absence of such a model, policymakers face a blizzard of recommendations, but few assurances that changes to domestic and international financial frameworks, most likely achieved with considerable institutional and political resistance, will preclude another crisis.

Currently, national governments are using a number of approaches to supervise financial markets. While the current situation is quite fluid, there seems to be some movement in national supervisory frameworks toward an integrated approach, as used in Great Britain and Germany. Regardless of which structural form is employed, regulating financial activities at the national level is complicated by the nature of modern financial markets that have become highly complex and interdependent. While regulation is set largely in a national context, financial institutions are international in their activities. Without consistent regulatory standards across national boundaries, banks, insurers, and securities companies can move their activities to jurisdictions with looser standards. National governments, however, generally are loathe to cede sovereignty to any supra-national institution, and efforts to reshape national financial authorities often face stiff opposition from entrenched interest groups.

Furthermore, national financial markets are not clones of one another, but reflect differences in the way they have been organized and philosophical differences over the way they are regulated and supervised. Indeed, national financial markets are custom-made structures that reflect differences in national experiences, government institutions, laws, and national customs. One thing the crisis has demonstrated, though, is that despite these differences, financial markets have become highly integrated. As a result, it has become increasingly more difficult, as evidenced by the current financial crisis, to contain financial problems in one market from affecting markets in seemingly unrelated areas.

The European Union has taken a number of steps to improve financial supervision among its members, including: strengthening the roles of advisory Committees in the areas of securities, banking, and insurance regulators; adopting regulations on credit rating agencies; providing funding in support of international accounting standards; and considering a measure to register hedge funds. The EU also adopted a proposal to have a European Systemic Risk Council and a European System of Financial Supervisors that will serve as advisors to EC members in providing advice in both macro and micro prudential supervision. The United States has chosen to take a different approach that could potentially strengthen the role of the Federal Reserve and create a new consumer watchdog agency, among other proposals.

The European Union

The European Union (EU) is a political and economic union of 27 member states, formally established in 1993 by the Treaty of Maastricht out of existing structures that had evolved in steps since the 1950s. The EU has worked to develop a single economic market through a standardized system of laws which apply across all member states and which provide the freedom of movement of people, goods, services and capital. This process of economic integration is complicated by a dual system that gives the members of the EU significant independence within the EU and broad discretion to interpret and implement EU directives. EU economic integration is compounded further by sixteen member states, collectively known as the Eurozone (1), which have adopted the euro as a common currency and operate as a bloc within the EU. Major institutions and bodies of the EU include the European Commission, the European Parliament, the Council of the European Union, the European Council, the European Court of Justice, and the European Central Bank (ECB). Through various Directives, the EU has moved to increase financial integration within the Union to make the monetary union represented by the Eurozone operate more efficiently.

Within the EU, the European Commission operates as the executive branch and is responsible for proposing legislation, implementing decisions, upholding the Union's treaties, and the general day-to-day running of the Union. The Commission operates as a cabinet government, with one Commissioner from each member. One of the 27 is the Commission President (currently Jose Manuel Barroso) appointed by the European Council, with the approval of the European Parliament, for a term of five years. Relative to the financial sector, the EU process provides for each member to have its own institutional and legal framework, which complicates efforts to coordinate financial policies. The Economic and Financial Affairs Council (ECOFIN) is one of the oldest bodies within the European Council. ECOFIN is responsible for economic policy coordination, economic surveillance, monitoring budget policy and preparing the EU's budget.

There are three main procedures the EU uses to enact legislation. These procedures are co-decision, assent, and consultation. The co-decision procedure, also known as the Article 251 procedure (Article 251 of the Treaty of Rome), is the main legislative process the EU employs to adopt directives and regulations. The Council and the European Parliament jointly adopt legislation based on a proposal by the European Commission. Both Parliament and the Council are required to agree on an identical bill before the measure can be adopted. In general terms, Parliament is considered to have adopted a measure if it fails to reject the proposed measure within three months after it has been adopted by the Council. Under the assent procedure, the Council can adopt a measure proposed by the Commission if it receives the assent of Parliament. Under the consultation procedure, the Council, acting unanimously or as a qualified majority, can adopt legislation developed by the Commission after it has consulted with Parliament.

Since the start of the financial crisis, the European Union has taken a number of steps to improve supervision of financial markets. These actions include:

* Strengthened the Committee of European Securities Regulators. The Committee is an advisory body without any regulatory authority within the European Commission. The Directive of January 23, 2009, strengthened the Committee's authority to mediate and coordinate securities regulations between EU members.

* Strengthened the Committee of European Banking Supervisors. The Committee is an advisory body without any regulatory authority that coordinates banking supervision. The EU Directive of January 23, 2009, broadened the role of the Committee to include supervision of financial conglomerates.

* Strengthened the Committee of European Insurance and Occupational Pensions Supervisors. The Committee is an advisory body without any regulatory authority within the European Commission in the areas of insurance, reinsurance, and occupational pensions fields. The January 23, 2009, Directive authorizes the Committee to coordinate policies among EU members and between the EU and national governments and other bodies.

* The European Parliament and the European Council approved on April 23, 2009 new regulations on credit rating agencies that are expected to improve the quality and transparency of the ratings agencies.

* Approved direct funding by the European Union to the International Accounting Standards Committee Foundation, the European Financial Reporting Advisory Group, and the Public Interest Oversight Body.

* The European Commission proposed a set of measures to register hedge fund …