The aim of this paper is threefold: first to establish how the regulatory and supervisory architecture has evolved in Europe over the last decade; second to determine how the shortcomings of the present system affected the onslaught of the financial crisis in Europe; and lastly to evaluate whether the proposed regulatory and supervisory reforms are likely to successfully repair these weaknesses. Part I identifies that the single market objective, combined with the significant integration of European financial services, provided the major impetus for bringing about reform to the regulatory and supervisory architecture of Europe. By investigating the Financial Services Action Plan (FSAP) and the implementation of the Lamfalussy Process, this paper illustrates that the member states and the EU institutions sought to achieve a flexible regulatory and supervisory structure marked by cooperation and conversion towards common standards. However, despite the commendable progress made, Part II shows that the regulatory and supervisory system has not kept pace with the financial integration, and that the current crisis revealed substantial inadequacies of the present system. This paper will demonstrate that the weaknesses in the European financial regulatory and supervisory architecture acted both as contributing causes of the crisis, and as exacerbating factors. In particular the essay identifies three such shortcomings that aggravated the crisis, namely that the current system caused a breakdown in member state cooperation and coordination, that it is marked by inconsistency, and that it lacks a sufficiently developed EU-dimension. Lastly, Part III investigates the proposed regulatory and supervisory reforms that the de Larosière Report brought forth. The Report makes recommendations for extensive reform and it is submitted that not only are these reforms likely to cure many of the current cooperation and convergence problems, but they would also equip Europe with a partially centralised supervisory structure that would help prevent future crises of similar cataclysmic proportions.
Introduction
The aim of this paper is threefold: first to establish how the regulatory and supervisory architecture has evolved in Europe over the last decade; second to determine how the shortcomings of the present system affected the onslaught of the financial crisis in Europe; and lastly to evaluate whether the proposed regulatory and supervisory reforms are likely to successfully repair these weaknesses. Part I identifies that the single market objective, combined with the significant integration of European financial services, provided the major impetus for bringing about reform to the regulatory and supervisory architecture of Europe. By investigating the Financial Services Action Plan (FSAP) and the implementation of the Lamfalussy Process, this paper illustrates that the member states and the EU institutions sought to achieve a flexible regulatory and supervisory structure marked by cooperation and conversion towards common standards.[1] However, despite the commendable progress made, Part II shows that the regulatory and supervisory system has not kept pace with the financial integration, and that the current crisis revealed substantial inadequacies of the present system.[2] This paper will demonstrate that the weaknesses in the European financial regulatory and supervisory architecture acted both as contributing causes of the crisis, and as exacerbating factors. In particular the essay identifies three such shortcomings that aggravated the crisis, namely that the current system caused a breakdown in member state cooperation and coordination, that it is marked by inconsistency, and that it lacks a sufficiently developed EU-dimension. Lastly, Part III investigates the proposed regulatory and supervisory reforms that the de Larosière Report[3] brought forth. The Report makes recommendations for extensive reform and it is submitted that not only are these reforms likely to cure many of the current cooperation and convergence problems, but they would also equip Europe with a partially centralised supervisory structure that would help prevent future crises of similar cataclysmic proportions.
Part I: Evolution of European Regulatory and Supervisory
System Prior to the Current Crisis
The single market objective, and the creation of a single market in financial services, is one of the fundamental aims of the EU. Recent years have witnessed important integrationist trends whereby integration is accelerating, financial institutions and activities are increasingly becoming pan-European, and financial product innovation and complexity is rising.[4] The integration of European financial markets has generated beneficial effects such as financial stability and efficiency[5], but it also raises the risk of cross-border contagion since events in one member state can have substantial impact on the financial markets elsewhere.[6] Accordingly, the recent interconnectedness of markets have made financial stability a matter of common concern for all member states, yet prior to 1999 financial policy was based on national regulation coupled with mutual recognition and on national supervision authorities with limited member state cooperation. This meant that the European system of regulation and supervision was decentralised and severely fragmented.[7] However, integrationist pressures from the single market objective, incentives from the expected economic benefits deriving from financial integration, and the perceived costs of non-reform were all factors that provided an impetus for reform of the regulatory and supervisory structure.[8] The push for reform was also anchored in an awareness that the then current regulatory and supervisory system was ill suited to keep pace with swiftly increasing integration, and that a centralised EU-level framework might be better at preserving financial stability amid the rising risk of cross-border contagion.[9] Consequently, the past decade has witnessed far-reaching regulatory and supervisory reform in the financial services industry, which began with the FSAP and the Lamfalussy Process.[10]
1.1. The FSAP and the Lamfalussy Process
The first step towards reform came in the shape of the FSAP, which was proposed by the Commission in 1999 and welcomed by the Lisbon European Council 2000 as part of the overall Lisbon Agenda of making EU the world’s most competitive economy. The FSAP was a blueprint with the aim of creating a single market in financial services through the implementation of 42 legislative proposals intended to further the integration of EU financial markets.[11] By the 2004 deadline, 93% of the proposals had been adopted and the FSAP was pivotal for the liberalisation of financial markets, and it largely harmonised European financial regulation.[12] The FSAP was replaced by the White Paper in Financial Services in 2005, which had better regulation and supervision as established priorities.[13]
The Lamfalussy Report triggered the debate on financial regulation and supervision of the European financial sector as a whole. The Lamfalussy Process is a complex decision-making procedure put into practice in 2001, both as a response to criticisms that the adoption-pace of financial legislation was too slow, and in order to make the regulatory and supervisory structure more flexible to deal with increasing integration and risk of cross-border contagion.[14] The aims of the Lamfalussy Process were to improve cooperation, coordination and convergence between the regulatory and supervisory authorities of the member states, and to generate trust between the regulators and supervisors by increasing consultation, transparency and accountability.[15] The Lamfalussy Process is a four-level decision-making structure: At level 1 the Commission proposes financial framework legislation after full consultation and the European Council and the European Parliament adopt it through the co-decision procedure.[16] Level 2 (L2) the Commission consults the L2 regulatory committees[17] and receives technical advice from the Level 3 (L3) supervisory committees.[18] The L2 committees then vote on the proposal, which is adopted by the Commission.[19] At L3, the L3 committees ensure the consistent and convergent transposition of the proposal at the national level by providing technical implementation advice and by issuing non-binding guidelines and uniform standards.[20] Level 4 is the enforcement phase at which the Commission monitors and enforces the correct transposition of EU legislation into national law, and brings infringements before the European Court of Justice.[21] The Lamfalussy process is not a centralisation of regulatory and supervisory responsibilities, but rather a multilevel institutionalised framework of enhanced national cooperation underpinned by EU-level committees.[22] Overall, the Process succeeded in making the European regulatory and supervisory system quicker and more flexible, and it is recognised to have taken important steps towards common standards, core principles and cooperation between member states.[23] Together with the FSAP, the Lamfalussy Process enabled the European regulatory and supervisory structure to develop from a minimal set of rules to an increasingly articulated and institutionalised framework.[24]
Part II: The Weaknesses in the European Regulatory and Supervisory
Structure That Both Caused and Exacerbated the Crisis
Europe is currently facing the most serious financial crisis since 1929, and it is described as one of the greatest challenges the EU has ever faced.[25] The crisis is believed to have many causes, but the fundamental failures in risk assessment by regulators and supervisors, made worse by the sheer complexity of new financial products that made risk unquantifiable, are identified as leading causes.[26] The crisis has worryingly revealed the weaknesses and inadequacy of Europe’s current financial regulatory and supervisory architecture.[27] In spite of recent reforms, the regulatory and supervisory structure has failed to keep pace with financial integration.[28] In order to be efficient, it is central that regulation, supervision and crisis management reflect the realities of the markets to which they apply.[29] Today’s increasingly integrated financial markets and pan-EU financial institutions necessitate an EU-level system of financial supervision due to potential risk contagion. However, in Europe supervisory competence remains firmly anchored at the national level, thereby preventing a European response to turmoil that might affect the stability of the entire financial market.[30] The present regulatory and supervisory structure does therefore not match the financial market realities and it is still unable respond to the challenges posed by an integrated financial market despite progress made.[31] In fact, as will be demonstrated, the failings of the European regulatory and supervisory architecture have acted both as contributing causes of the crisis, and as exacerbating factors.
2.1. Regulatory and Supervisory Shortcomings that were Contributing Causes of the Crisis
This paper identifies three regulatory weaknesses and three supervisory shortcomings that arguably directly contributed to the financial crisis. First, the so-called ‘parallel banking system’ that encompasses hedge funds, investment banks and various off-balance sheet items, was not sufficiently regulated even though it was clearly able to have systemic impacts.[32] The inadequacy of the regulatory regime in relation to the parallel banking system, in combination with severely lacking transparency and extreme complexity of financial products, is undoubtedly a cause of the crisis.[33] Secondly, the current European regulatory framework is strongly pro-cyclical as a result of both the “interaction of risk-sensitive capital requirements and the application of the mark-to-market principle in distressed market conditions”.[34] As a result European regulation actually contributed to cyclicality and lessened financial stability, which were also causes of the crisis. Lastly, European financial regulation can be seen to have indirectly fomented the crisis by creating an illusion of control and a false sense of security, which was strengthened by the absence of early warnings of dangers due to a flawed risk warning framework.[35]
The first supervisory weakness that was a contributing factor in causing the crisis was the inadequate infrastructure for risk assessment and crisis management in Europe. Despite a multitude of committees, crisis management at the EU-level remains insufficient, opaque and inefficient.[36] As a result, there were few or no warnings of the imminent financial dangers arising from the build-up of risk and imbalances, and if warnings were issued there was no consensus or formal process that determined what action ought to be taken.[37] This effectively precluded crisis prevention and was accordingly a cause of the crisis. Secondly, the present decentralised supervisory system focuses on micro-prudential supervision of individual financial institutions. In the period preceding the crisis this meant that supervisors were paying insufficient attention to the macro-systemic risks of contagion and to the revealing trends that were sweeping the entire financial sector, and this failure constitutes one of the indirect causes of the crisis.[38] Lastly, supervisory authorities in Europe showed poor judgment and severe lack of understanding regarding new complex financial products, and supervisors were therefore unable to quantify the risk these products carried.[39] This led to an underestimation of overall risk, failures to issue warnings and consequently a breakdown in crisis prevention.
2.2. Regulatory and Supervisory Shortcomings that Exacerbated the Crisis
Since financial integration increases the risk that failure in one member state will lead to cross-border contagion, a single financial market necessitates not only increased cooperation between member states due to the shared responsibility for financial stability, but also consistency in implementation of financial regulation and coherent carrying out of supervisory activities. Furthermore, the need for European-wide cooperation is amplified in a cross-border systemic crisis situation both because national responses are inadequate to solve a European (global) financial crisis, and because the large pan-EU banks and financial institutions of today are too great for any one government to rescue.[40] For these reasons the crisis has made it increasingly clear that concerted European action and an EU-dimension are absolute necessities.[41] However, the European system of financial regulation and supervision remains decentralised, fragmented and marked both by national inconsistencies in implementation and enforcement of EU regulation, and by member state divergences in financial supervision. In particular the author identifies the breakdown in member state cooperation and coordination, the inconsistency of the system, and the absence of a sufficiently developed EU-dimension as the core reasons why the current regulatory and supervisory structure acted to exacerbate the crisis.
[...]
[1] Communication from the Commission “Review of the Lamfalussy Process, Strengthening Supervisory Convergence”, COM/2007/0727 Final, 20th November 2007, p.1 and p.6.
[2] Lannoo “The Crisis, One Year On” CEPS Centre for European Policy Studies, August 2008, p.1 and p.2, available at http://shop.ceps.eu/BookDetail.php?item_id=1690. See also ACCA “How Should the EU Respond to the Financial Crisis?” ACCA, 2009, pp.1-9, p.8, available at http://www.accaglobal.com/pubs/publicinterest/pressandpolicy/unit/european_briefings/financial_crisis.pdf.
[3] The de Larosière Report – The High-Level Group on Financial Supervision in the EU, 25th February 2009.
[4] Op. Cit. COM/2007/0727, p.2.
[5] Memorandum of Understanding on Cooperation Between the Financial Supervisory Authorities, Central Banks and Finance Ministries of the European Union – On Cross-Border Financial Stability, June 2008, pp.1-37, p. 2, available at http://www.finance.gov.ie/documents/publications/other/MOUcbankjune08.pdf.
[6] Commission Decision, 2009/79/EC, L25/28 “Establishing the Committee of European Insurance and Occupational Pensions Supervisors”, January 2009, p.2.
[7] Quaglia “The politics of financial services regulation and supervision reform in the European Union” European Journal of Political Research, Volume 46, Issue 2, February 2007, pp. 269-290, p.271.
[8] Ibid. p.278.
[9] Lastra “The Governance Structure for Financial Regulation and Supervision in Europe” Colombia Journal of European Law, Volume 10, 2003, pp.49-68, p.1 and p.7. See also Schoenmaker and Oosterloo “Cross-Border Issues In European Financial Supervision”, February 2005, pp.1-25, p.19, available at http://staff.feweb.vu.nl/dschoenmaker/Cross-border%20issues%20(BoF%2021-2-2005).pdf.
[10] Lannoo “Concrete Steps Towards More Integrated Financial Oversight – The EU’s Policy Response to the Crisis” CEPS Taskforce Report, December 2008, pp.1-62, p.31, available at http://shop.ceps.eu/BookDetail.php?item_id=1762. Referred to as ‘Lannoo (a)’ from here onwards.
[11] CEPS “After the Financial Services Action Plan: A Repeat of the post-1992 Blues?” CEPS Centre for European Policy Studies, 19th February 2007, available at http://www.ceps.eu/Article.php?article_id=468&.
[12] Ungureanu and Dragomir “Evolution of Accounting and Financial Sector Regulation Within the European Union Policy” July 2008, pp.1-17, p.2 and p.7, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1144723.
[13] Stichele “Financial Regulation in the European Union – Mapping Decision Making Structures on Financial Regulation and Supervision” December 2008, pp.1-73, p.13, available at http://www.eurodad.org/uploadedFiles/Whats_New/Reports/EUMapping_Financial_Regulation_FINAL.pdf.
[14] Op. Cit. Lastra (2005): p.13-14. See also Op. Cit. Quaglia (2007): p.274.
[15] Op. Cit. de Larosière Report (2009): p.76.
[16] Visscher and Maiscocq and Varone ”The Lamfalussy Reform in the EU Securities Markets: Fiduciary Relationships, Policy Effectiveness and Balance of Power” Journal of Public Policy, Volume 28, 2008, pp.19-47, p.3, available at www.eu-newgov.org/datalists/publications_detail.asp?Project_ID=07.
[17] European Banking Committee (EBC); European Insurance and Operational Pensions Committee (EIOPC); and European Securities Committee (ESC).
[18] Committee of European Banking Supervisors (CEBS); Committee of European Insurance and Operational Pensions Supervisors (CEIOPS); and Committee of European Securities Regulators (CESR).
[19] Op. Cit. Stichele (2008): p.15 and p.17.
[20] Op. Cit. COM/2007/0727, p.2. See also Op. Cit. Commission Decision, 2009/79/EC, L25/28, p.2 and p.4.
[21] Op. Cit. Visscher and Maiscocq and Varone (2008): p.3.
[22] Op. Cit. Quaglia (2007): p.273. See also Op. Cit. Lastra (2005): p.11.
[23] Quaglia “Explaining the Reform of Banking Supervision in Europe: An Integrative Approach” Governance, Volume 21, Issue 3, July 2008, pp. 439-463, p.445.
[24] Op. Cit. Quaglia (2007): p.273.
[25] European Council, Presidency Conclusions, Brussels 19/20 March 2009, 7880/09, Conclusion 1, p.2.
[26] Beashel “The de Larosière Report – A Roadmap for Important Changes in the Financial System” Finance Magazine Online, April 2009, available at http://www.finance-magazine.com/display_article.php?i=9030. See also Op. Cit. de Larosière Report (2009): p.9.
[27] Lannoo “The Crisis, One Year On” CEPS, August 2008, available at http://shop.ceps.eu/BookDetail.php? item_id=1690. Referred to as ‘Lannoo (b)’ from here onwards.
[28] Persaud “The Financial Crisis May Hasten European Integration but Slow Global Banking” in Felton and Reinhart “The First Global Financial Crisis of the 21st Century – Part II, 2008, pp.1-390, p.81, available at http://www.voxeu.org/reports/reinhart_felton_vol2/First_Global_Crisis_Vol2.pdf#page=79. See also Op. Cit. European Council Presidency Conclusions, 7880/09, p.2.
[29] Op. Cit. Lastra (2005): p.3. See also Op. Cit. Lannoo (a) (2008): p.40.
[30] Lannoo “It’s High Time to Create a Truly European System of Financial Supervisors” CEPS, June 2008, available at http://shop.ceps.eu/BookDetail.php?item_id=1679.
[31] Di Noia “A Proposal on Financial Regulation in Europe for the Next European Council” in Felton and Reinhart “The First Global Financial Crisis of the 21st Century – Part II, 2008, pp.1-390, p.66, available at http://www.voxeu.org/reports/reinhart_felton_vol2/First_Global_Crisis_Vol2.pdf#page=79.
[32] Op. Cit. de Larosière Report (2009): p.24.
[33] Op. Cit. ACCA (2009): p.4.
[34] Op. Cit. de Larosière Report (2009): p.18.
[35] Ambler “The Financial Crisis: It Regulation Cure or Cause?” Adam Smith Institute, 2008, p.1-2, available at http://www.adamsmith.org/blog/regulation-and-industry/regulation-and-the-financial-crisis-200811272501/.
[36] European Shadow Financial Regulatory Committee “Statement No. 27 - Resolving the Current Crisis and Preventing its Return” March 2008, available at http://www.ceps.be/Article.php?article_id=583.
[37] Op. Cit. de Larosière Report (2009): p.12 and p.41.
[38] White “Key report on banking reform calls for financial risk watchdog, but no joint EU bank oversight” AP Business Writer, February 2009, available at http://www/apbusinesswriter.org/publications_detailID=3490.
[39] Tabellini “Why Did Bank Supervision Fail?” in Felton and Reinhart “The First Global Financial Crisis of the 21st Century, Part I”, 2008, pp.1-204, p.45, available a http://www.tek.org.tr/dosyalar/21st_ CRISIS.pdf#page=55.
[40] Marsden “EU call for global financial regulation masks intra-European and international tensions” Global Research, October 2008, available at http://www.globalresearch.ca/index.php?context=va&aid=10584.
[41] Op. Cit. European Council Presidency Conclusions, 7880/09, p.4.
- Citar trabajo
- Veronica Hagenfeldt (Autor), 2009, European financial regulation and supervision and the onslaught of the financial crisis, Múnich, GRIN Verlag, https://www.grin.com/document/169761
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