The identification and management of risks, both within the individual entity and at the systemic level, is a focal point of the debate on the regula- tion and control of financial markets and an essential step in guaranteeing the stability of participants and the system overall. As became even more obvious during the current financial turmoil, the lack of awareness of the real risks present on the market was an obstacle to the prevention of sys- temic threats;4 while the way in which the crisis was managed laid bare all the limitations of an approach which, except for a few fleeting episodes of coordination made necessary by the gravity of the moment, was not at all global, and was based on purely domestic measures.
On the subject of reform, the approach adopted by the de Larosière Report draws a clear dividing line between two separate problematical areas: on the one hand, the prevention and management of crises affecting individual financial entities (the task of micro-prudential supervision) and on the other, risk prevention and management for the system as a whole, known as macro-prudential supervision, different and separate from micro- supervision and thus assigned to a different authority. In actual fact, the two forms of supervision are closely connected, and in their document commenting on the proposal the three committees, the CESR, CEBS and CEIOPS, are in no doubt about the potential improvements it may bring, but also highlight the need for greater dialogue between the two levels of supervision, which will also prevent duplication (CESR, CEBS and CEIOPS, 2009).
As things now stand, the draft directive on capital adequacy already dis- cussed contains a number of points which clearly acknowledge the close link between the two supervisory levels. This is particularly evident in art. 42a (new), which introduces the concept of the ‘systemically relevant branch’.
Branches are defined as systemically relevant further to an application, with reasons, from the host member state, which must be made with particular
of clients, or to whether the suspension or closure of the operations of the credit institution might impact on market liquidity and the payment and clearing and settlement systems. The relative decision-making mechanism allows the competent authority of the host country, which made the appli- cation, to reach its own decision on the matter if no agreement is reached between those involved, such as the consolidating supervisory authority for the aspects under its control and the home member state authorities for the areas under their jurisdiction. Specifically, the authorities must do
‘everything within their power to reach a joint decision’ within two months of the application, and otherwise the applicant authority will decide within the next two months, taking views and reservations into account. A branch is designated as systemically relevant by means of ‘a document containing the fully reasoned decision’, transmitted to the competent authorities con- cerned, recognised as determinative and applied by the competent authori- ties in the member states concerned. This definition makes no changes to the approach and responsibilities with regard to supervision, but simply strengthens the exchange of information between the authorities involved, especially in ‘emergency situations’, in which it is particularly important for the multilateral exchange of information to take place without difficulties and obstacles (art. 42a (new) (2) and (3)).
In spite of the many opinions which identify the European Central Bank as the natural assignee of powers and responsibilities with regard to macro- prudential supervision (de Larosière Report, p. 42 s.), the proposal has been made for the creation of a new authority, called the European Systemic Risk Council (ESRC), operating within the ECB and with the participation of the central banks belonging to the ESCB. The proposed ESRC will consist of the chair – who will also become its chair – and deputy chair of the ECB, the 27 National Central Bank (NCB) governors, and the chairs of the CEBS, CEIOPS and ESRC, together with a representative of the European Commission (Figure 9.1). Moreover, in view of the different approaches to supervision adopted in the individual member states, the group is to ‘interact closely with the supervisory authorities which are not part of the central banks’, which will participate in discussions whenever necessary. In practice, therefore, the competent authorities for micro-prudential supervision in the individual states are not full members of the new body, with all the potential problems this may involve. The new authority is competent with regard to assessments and recommendations in the area of macro-prudential supervision, with a particular emphasis on risk warning and the issue of guidelines on prudential supervision. To enable it to function, the ESRC will receive a constant flow of compulsory information from the national central banks, and a manda- tory follow-up from the national supervisory authorities in response to risk warnings. The ESRC also specifies who is to implement its recommendations,
and if the response is inadequate, it notifies the Economic and Financial Committee (political authority).
The de Larosière Report’s recommendations have met with general approval within the EU, although they are objectively only a compromise solution for those in favour of a more robust, better structured centralised supervisory system, with stronger powers over entities with systemically relevant size and characteristics. In the future, and this is already reflected in the debate underway at the EU level, it will be necessary to solve the problem of possible trade-offs between the areas of competence of the sys- temic controller and the fact that the costs for any bank rescue packages will still be met at the national level. This trade-off is itself symptomatic of the fact that once this option has been chosen, if it is to be effective European supervision will inevitably have to be combined with the centralisation of areas of competence and the uniformity of measures to be paid for by the taxpayer, only achievable with a high degree of political convergence between the member states; in spite of the current financial turmoil, there as yet no signs of this emerging.
European System of Financial Supervision (ESFS) Macro-prudential
supervision
Information on micro-prudential developments
Micro-prudential supervision
Early risk warning
⫹ ⫹
European banking authority (EBA)
National banking supervisors
National insurance supervisors
National securities supervisors European
insurance authority (EIA)
European securities authority (ESA) Chairs of
EBA, ELA and ESA Members of
ECB/ESCB general council (with alternates where necessary)
European commission
Figure 9.1 European Framework for Safeguarding Financial Stability
Source: The High Level Group on Financial Supervision in the EU, chaired by J. de Larosière (2009), Report, 25 February, p.56.
The process of innovation which has affected the financial markets over the last decade has generated a new willingness on the part of intermediaries to internationalise both their business, which is becoming more and more inter-sectorial, and their ownership structures.
This transformed scenario made it essential to review the rules, which have accordingly began to reflect a desire for international regulation, in both the attempt to adopt rules shared by groups of states, and the intro- duction of mechanisms intended to facilitate the cross-border supervision of companies. However, the measures taken proved insufficient and the financial crisis overwhelmed intermediaries and markets, demonstrating the inability of a system still firmly anchored to a nationalistic approach to regulate a market which increasingly knows no borders.
The growth of cross-border groups, in particular, has inevitably amplified the effects a crisis hitting an intermediary can trigger on the market (and not just the market of the individual country but that of the single European market itself). The importance of what is at stake could not be more obvi- ous, and all those involved on the European scene have come together in the common effort to achieve a reform which will strengthen the Europe- wide character of supervisory activities as soon as possible. The European Commission, the Council of Europe and the European Parliament are taking action in several areas, and all agree on the urgent need for a complete over- haul of the regulatory framework in the shortest possible term. However, there is no concealing the fact that the creation of a common purpose within the European Union always goes hand-in-hand with the member states’ affirmation and defence of their specific national systems, and the thus the achievement of an agreement is often a matter of compromises and lengthy time-scales. It is unanimously acknowledged that the current circumstances demand a rapid response, and if the proposed schedule is complied with, the EU legislators will have accelerated the process to an impressive degree. However, even if the new measures are introduced con- siderably more swiftly than the reforms implemented so far, there is still the risk that they will prove to be too little, too late.
It is assumed, as the de Larosière Report also pragmatically accepts, that the proposed reforms will be compatible with the EU Treaty, and will there- fore not involve the very lengthy procedure of constitutional reform.
The first in the raft of measures is about to be completed. It is expected that the revision of Directive 2006/48/EC will be definitely approved by the end of 2009. The European Parliament has recently accepted5 the Commission’s proposal for a number of amendments, which, however, do not clear up the doubts expressed about the efficacy of a system that still leaves all the power and responsibility of the home country supervisory authority intact, con- firming the policy of maintaining the principle of home country control as
coordinate their actions with other competent authorities and where appro- priate with central banks in an efficient way, including with the aim of mitigat- ing systemic risk’. The doubts persist concerning the usefulness of supervision which continues to be grounded merely on coordination and information exchange, without the creation of an authority with the powers to direct and issue guidelines for the process, or to resolve any disputes between the competent authorities involved, let alone to take rapid action if intermediar- ies are hit by crises which, by their very nature, must be dealt with through quick, targeted measures. On this last point, the issue of a Memorandum for financial stability, with the aim of improving coordination and intro- ducing joint principles for the crisis management, proved insufficient to allow a rapid response to instability with implications for the entire system.
The reform of the capital adequacy directive has the merit of making the intervention of the Colleges of Supervisors compulsory where the voluntary mechanisms previously adopted have proved inadequate, but its reinforce- ment of these bodies’ role and area of jurisdiction is insufficient.
The heart of the ongoing reform is the new institutional framework which has taken shape over the past few months, starting from the recom- mendations of the de Larosière Report. We have seen that policy is moving towards the establishment of two pillars on which measures will be based:
micro-prudential supervision, assigned to the European System of Financial Supervision; and macro-prudential supervision, to be entrusted to the European Systemic Risk Council.
The first criticism that can be levied at an approach of this kind concerns just this separation between the two levels of supervision, since the effective prevention and control of systemic risk is impossible without the considera- tion, assessment and control of individual institutions. Careful evaluation is thus required of both the assignment of areas of jurisdiction and roles, while effective mechanisms for the coordination of the two forms of supervision are also needed (Tarantola, 2009).
Moreover, as things now stand there is no clear identification of what can and must be considered ‘relevant’ for the containment of systemic risk.
We have seen that art. 42b of the new capital adequacy directive introduces the concept of the ‘systemically relevant branch’. The directive provides a number of guidelines to be used by the home country authority for the iden- tification of branches in this category, but in our view they are ineffectual and too vague, since they consider the branch’s market share in terms of deposits (with a 2 per cent threshold), its size and importance, its number of clients, and whether the suspension or closure of the operations of the credit institution might impact on the liquidity of the market, and the pay- ment and clearing and settlement systems. One of the tasks to be assigned to the new macro-prudential supervisory authority is the identification and
recommendations, both of a general nature and addressed to individual member states, which will not be compulsory, although an ‘act or explain’
mechanism is envisaged to ensure that they receive due consideration. No solution is thus provided to the problem of how to deal with possible con- flicts between supervisory authorities when it comes to the identification of systemically relevant branches.
According to the Commission,6 micro-prudential supervision will continue to be the task of the national authorities, but the ESFS will have the power to issue technical standards binding on them, capable of ensuring consistent, uniform application with reference to a number of as yet unspecified sectors to be defined in EU law. At the same time, if discrepancies persist and con- flicts arise, the new authority will be able to issue decisions binding on both the national authorities and the CoS, although only as ‘ultima ratio’, and this does provide at least a partial solution to the problems highlighted above.
To be effective, the supervision of cross-border groups in particular requires, if not the introduction of a single regulator and supervisor (in our view the preferred solution), at least the adoption of mechanisms capable of ensuring that all the authorities involved follow the same rules of behaviour when it comes to controlling each individual organisation. For the time being, no solution is proposed to the need to ensure crises are dealt with through the immediate, effective intervention of a single, specific supervisory body, with powers appropriate to the needs arising from systemic risks.
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Consolidation in the Stock Exchange Industry
Giusy Chesini