regulatory aspects from an english and european …00000000-6ef1-da2a-0000...• solution? →...

Regulatory Aspects From an English and European Point of View

29-30 August 2013

University of Stockholm Marianne och Marcus Wallenbergs Stiftelse

Functional or dysfunctional – the law as a cure?

Risks and liability in the financial markets

Professor Kern Alexander, Chair for Law and Finance

University of Zürich

Kern Alexander 1

FSA 2011 2

FSA 2011 3

UK Banks’ Leverage

Sources: United Kingdom: Sheppard, D (1971), The growth and role of UK financial institutions 1880-1962, Methuen, London; Billings, M and Capie, F (2007), 'Capital in British banking, 1920-1970’, Business History, Vol 49(2), pages 139-162; BBA, ONS published accounts and Bank of England calculations

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From Micro to Macro-prudential Regulation

• “Micro prudential concerns itself with factors that effect the stability of individual institutions. Macro prudential regulation concerns itself with factors that affect the stability of the system as a whole.

• ..the nature of regulation applied to an individual institution depends crucially on how “systemic” its activities are.

• This is related .. to its size, degree of leverage and interconnectedness ….”

(Brunnermeier, Crockett, Goodhart, Persaud and Shin, 2009)

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7

Macro-prudential Regulatory Measures

• Affect balance sheets of financial institutions

Capital requirements - counter-cyclical capital buffers to dampen credit cycle. Restrictions on distributions & remuneration

Liquidity tools: Time-varying liquidity buffers, liquid assets, bank funding restrictions/limits, maximum leverage ratios

Forward-looking loss provisions: required to set aside provisions against potential future losses on their lending

• Affect terms and conditions of transactions

Loan to income ratios/Loan to value ratios.

Collateral requirements (higher if lending above trend)

Securities lending limits and margining requirements

• Affect market structures

Clearing houses; trading venues/capital controls; settlement, central securities depositories

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UK Regulatory Restructuring

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Financial Services Act 2012

Source: HM Treasury Cm 8083, June 2011, p. 8

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UK Regulatory Approach Misjudged the

Risks

• Sir Mervyn King, Governor of the Bank of England (Nov 2012)

‘The reason we want to move towards a twin-peak approach is that it is a question of judgment and culture, not structure. I came to see that it proved extraordinarily difficult to enable the regulators to make judgments in the field of prudential regulation when the same people were being asked to carry out conduct of business, enforcement and consumer protection regulation, which by its nature has to be rule-based, is highly legalistic and will appear rather bureaucratic. It is very important to get away from that when it comes to prudential regulation.

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The Parliamentary Joint Committee Does Regulatory Structure Matter?

• No regulatory structure can guarantee against bank crises

• However, legislation should make provision for handling crises and resolving bank/investment firm failures

• Legislation should have balanced objectives: conduct of business ethos to protect investors and customers, promote competition, and focus on prudential and financial stability risks

– Australia: Twin Peaks (APRA & securities regulator)

– Canada: Central bank, bank supervisor, provincial securities regulators

– The Netherlands & Spain (central bank and securities regulator)

– USA: multiple federal & state regulators

– Switzerland: EBK, FOPI, AMA and SNB changed to FINMA & SNB

– Single regulators: Germany/BaFin, Sweden, Japan, & South Korea

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Successful Regulation and Supervision Depends on

• Culture

– Rigorous challenge of bank risk models and governance – Shareholder stewardship (sustainable profits and mitigate social costs)

• Focus

– Pro-active oversight of whole financial system (macro-prudential) – Forward looking assessment of potential risks (not backward looking

legalistic rules) – Firms should address conflicts of interest and consumers’ need for timely,

accurate and intelligible information

• Philosophy - Macro-prudential systemic risks and controlling externalities - Firms should act honestly, fairly and professionally in best interest of

customers - Exercise of supervisory judgement based on discretionary powers

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13

Legislation Can Influence Culture, Focus and Philosophy

• Setting clear objectives

• Effectively allocates powers and responsibilities • Establishes appropriate system of accountability of regulatory bodies to

the Treasury and Parliament

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Judgment-led Supervision

• Sir Mervyn King, Governor of the Bank of England (Nov ‘12)

‘we feel so strongly that the culture of regulation needs to get away from this game in which the regulator writes ever more complex regulations and the banks and their lawyers write new products, which are essentially the same as the previous ones but are defined in such a way as not to be caught by the latest rule and regulation. This leads to a very expensive and unnecessarily complex system.’

‘[T]o get over this, we should make sure that regulation is about judgment so that the examples about complexity, opacity and simple leverage are ones that the regulator can say, “frankly, we do not understand why your organisation needs to be so complex. We cannot work out what you are doing, so you will have to change it. You have not broken a rule, but too bad: you have to change it”’

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European Union/ Euro Area

New EU Structure of Financial Supervision

European Systemic Risk Board (ESRB)

EBA European

Banking Authority

ESMA European Securities &

Markets Authority

National Supervisors Responsible for day-to-day supervision, cooperating in colleges

Information exchange Advice and warnings

EIOPA European Insurance

& Oc. Pensions Authority

Send Board Members Decisions in specific cases

•Identifies potential stability risks

•If necessary, recommends action to EU or national authorities

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EU Micro-prudential regulation

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ESAs & Commission Standard Setting

• Interaction in the procedure for adoption of technical standards

– ESA develops draft standards

– COM adopts the standards

– COM can reject or amend only where the Union interest so requires

=> sending back to ESA for comment

=> Commissioner can be invited to EP and Council

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ESAs & Commission Powers

ESA breach of law powers

• ESA can issue recommendation to national authorities

• If national authorities don’t comply, Commission can issue a formal

opinion addressed to national authorities

• In case of further non-compliance, ESA can under certain circumstances

address a decision directly to the financial institution concerned

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20

Legal Issues of ESA Rule-Making

• Article 114 TFEU as a legal basis

• Meroni doctrine: discretionary powers for a new ‘institution’ not permitted

• Solution: Commission’s role in application of direct powers for ESAs

• De facto EU federal supervision

• Recital 62 of preamble to draft Directive: “(. . .) to entrust EBA with the elaboration of draft regulatory and technical standards which do not involve policy choices, for submission to the Commission”

• Articles 10 and 15 Regulation 1093/2010 (EBA): “no strategic decisions or policy choices”

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ECB

Significant credit institutions (or within top 3 in MS)

NCA

Authorisation + holdings

acquisition / disposal

…….

Regulations,

guidelines, general

instructions

Task explicitly

included in SSM

Draft Regulation

(Art. 4 - 4a)

Task based on

MS national

supervisory law

“When necessary”; upon

request, or on its own

after consulting NCA

Remaining SSM tasks

Not significant Not a credit institution

under EU Law

Banking Union - supervision pillar The Single Supervisory Mechanism

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Structural Regulation and Ring-Fencing • Financial Stability Board Key Attribute 10.5:

• “To improve a firm’s resolvability, supervisory authorities or resolution authorities should have powers to require, where necessary, the adoption of appropriate measures, such as changes to a firm’s business practices, structure or organisation […] To enable the continued operations of systemically important functions, authorities should evaluate whether to require that these functions be segregated in legally and operationally independent entities that are shielded from group problems.”

• Current UK Banking Reform Bill: ring-fencing of retail deposit-taking activities from rest of the group (follows Vickers Proposal from 2011). Subsidiarised banks and higher regulatory capital (9.5% tier 1). What type of firewalls around ‘narrow bank’ subsidiaries. Reputation risk however. What if investment bank fails?

• Liikanen Report: additional ring-fencing of investment bank if necessary for the bank’s orderly resolution.

• Compare contention of the European Banking Federation (EBF): “there is no convincing evidence that structural reform has a direct influence on systemic risk and would make restructuring or resolution easier in the event of a crisis.”

• Volcker Rule on proprietary trading, s. 619 Dodd-Frank Act Prof. Kern Alexander

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The Lessons – The New Mindset

• Financial regulation generally failed to address the changing nature of systemic risk in wholesale capital markets and the risks inherent in financial innovation

• Greater recognition of interconnectedness of markets and systemic risk and relationship of macro-economic policy to financial stability.

• Problem of TBTF/LCFI whose diversification and size have consequences for financial stability.

• Controls on cross-border capital?

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John Kenneth Galbraith, The Great Crash 1929

• “No one was responsible for the Great Wall Street crash. No one engineered the speculation that preceded it. Both were the product of the free choice and decisions of thousands of individuals. The latter were not led to the slaughter. They were impelled to it by the seminal lunacy which has always seized people who are seized in turn with the notion that they can become very rich. There were many Wall Streeters who helped to foster this insanity, and some of them will appear among the heroes of these pages. There were none who caused it.

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ECB as Single Supervisory Mechanism (SSM)

• 12th September 2012: SSM Proposal

• SSM responsible for licensing, monitoring and enforcing prudential

regulations against Eurozone banks

• Art. 4(1)(k): ex-ante supervision

• No actual ex-post resolution and crisis management powers over Eurozone

banks or even over national authorities

• Solution? → institutional and legal obstacles to consider

• 19th September announcement: Bank Recovery and Resolution Directive to

be amended in order to match SSM Proposal

12.11.2012 Bank Recovery and Resolution, Prof. Kern

Alexander Seite 25

Prof. Kern Alexander 26

Changes in the SSM Proposal Tasks and Powers

• Reassignment of supervisory tasks between ECB and NCAs (National Competent Authorities)

– ECB directly supervises «more significant» credit institutions (+ any financially assisted credit institutions)

– NCAs directly supervise «less significant» credit institutions (still subject to ECB instructions, guidance and exceptional intervention)

• Macroprudential tasks carved out, now primarily an NCA task


Changes in the SSM Proposal Tasks and Powers

• Resolution powers excluded

• Powers under Commission proposal:

– All powers held by national competent authority under relevant Union Law

– + SSM-specific powers, but only investigation, authorisation and sanctions

• Presidency compromise adds extensive set of SSM-specific supervisory powers


Changes in the SSM Proposal Organisation & Procedures

• Staff separation between monetary policy / supervision

• Chair appointed by ECOFIN, cannot be Governing Council member

• Supervisory decisions drafted by Supervisory Board, submitted to Governing Council for formal approval

• Reporting requirements towards national parliaments added

• Due process for all persons subject of ECB proceedings

• Internal «Panel of Review» can confirm, abrogate, or amend any SSM decision (ECB or NCA) upon request


Changes in the SSM Proposal EBA voting

• Amended EBA voting modalities in Commission proposal

• Opinions still divided; how to achieve balance between non-participating and participating Member States through double majorities, reverse majorities, token panel members etc.?

• Presidency compromise offers two options for each item:

Independent panel decisions: SMV A and SMV B

Regular vote on EBA matters: QMV A and QMV B


Changes in the SSM Proposal: March 2013 Deal

• Agreement between EP and Council, reportedly secured SSM regulation

• Changes in key area pushed by Parliament negotiators:

Stronger accountability of supervisor; co-appointment and dismissal of Chair and Vice Chair + better access to information for the European Parliament.

Stronger role for national parliaments

Better access to documents both for the EU supervisory authority vis-à-vis banks and for EP and national parliaments vis-à-vis EU supervisory authority

Attractive participation conditions for Non-Eurozone countries

Strict division of European Central Bank staff between monetary policy and supervision,

Strengthening of European Banking Authority, in relation to the ECB, improving ability to undertake stress tests and obtain information

Establishing a system which will uphold the diversity of the EU banking sector

30.09.2013 Kern Alexander Seite 31

Changes in the SSM Proposal EBA voting changes

• Opinions still divided; how to achieve balance between non-participating and participating Member States through double majorities, reverse majorities, token panel members etc.?

• Presidency compromise offered two options for each item:

Independent panel decisions: SMV A and SMV B

Regular vote on EBA matters: QMV A and QMV B

European Banking Authority’s Powers

• Generally, EBA proposes technical implementing standards to Commission for approval on matters delegated by EU law.

• Art 1(2) Reg. 1093/2010. CRD packages, FCD, DGS etc (including subsequent directives/regulations/decisions) based on them

• Art 17. EBA power to investigate and take action against potential breaches of EU law falling within scope defined above (including EBA regulatory technical standards) when committed by a ‘competent authority’ (the definition would also include ECB, COM 2012/512, Art 1 para 1)

• Art 19 – EBA binding settlement of disagreements between competent authorities in cross-border situations, namely where ‘a competent authority disagrees about the procedure or content of an action or inaction of [another] competent authority in cases specified in acts referred to in Art 1(2)’.

• Art 21 – ‘Colleges of supervisors’ under the CRD regimes. EBA shall have a legally binding mediation role to resolve disputes between MS

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EU Bank Recovery and Resolution Framework

• Draws considerably from UK Banking Act 2009; also includes FSB’s Key Attributes

• Scope identical to that of Capital Requirement Directive (= credits institutions,

financial groups and conglomerates, certain investment firms)

• Member States must designate a resolution authority with set of “minimum”

resolution tools:

o Sale of business tool

o Asset separation tool

o Bridge institution tool

o Bail-in tool

• However minimum harmonisation Directive: discretion of MS whether to adopt

resolution tools

• Authority has power to veto intra-group financial support agreements, but also

power to enforce them once concluded (relation to ring-fencing?)


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EU Bank Recovery and Resolution Framework

• RRP requirements, with EBA to draft implementing standards including

minimum content

• Competent authority reviews RRP, can adopt measures to overcome

deficiencies or potential impediments to the plan’s feasibility

• Funding arrangements

o MS-based; EU-wide resolution fund considered but rejected

o Financed ex-ante by the institution themselves

o Deposit Guarantee Schemes (→ Directive 94/19/EC) may be used for

this purpose

o Funding target level: 1% of the deposits of all credit institutions

authorised in the Member State’s territory, to be guaranteed within 10

years following the entry into force of the Directive


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35 35

The rule of law and financial regulation

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• Judgmental led supervision – less reliance on legalistic rules

and more supervisory discretion – ‘if a bank appears to the

supervisor to be too complex, the supervisor should be able

to make it become simpler’ not constrained by

legal/regulatory rules. Broad discretionary powers

Legality,

Due process, and

Proportionality

• Do supervisory assessments and decisions for a firm to take

action need to be grounded in existing conditions for

authorisation? That are ruled-based? and/or principles?

• What scope for judicial review of supervisory/regulatory

decisions?

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