1. The European System of Financial Supervision: Managing the triangular between the ESRB, ESAs, and ECB/ESCB 26 April European Commission FP7’s 8th Augur Workshop Wiener Institutfür Internationale Wirtschaftsvergleiche (wiiw)
Prof Dr. Kern Alexander, Chair for Law and Finance,
University of Zürich, and
Member of the European Parliament’s
Expert Panel on Financial Services &
Specialist Adviser, UK Parliament’s Joint Committee on the Financial Services Bill

2. Analysis of EU Financial Regulation
Increasingly integrated EU financial markets
Centralised governance structure and risk management of largest 50 or so EU financial institutions
Was the home/host/Lamfalussy framework adequate?
Further institutional consolidation at the EU level with ESAs and harmonised regulatory rulebook
Far reaching re-appraisal of the role of EU financial regulation in controlling ‘externalities’ and developing uniform rules, technical standards and guidelines to enhance the implementation of micro-prudential regulation and macro-prudential supervision
Will this lead to more EU/euro area institutional consolidation?

3. European System of Financial Supervision
European Systemic Risk Board (ESRB)
[Chair, President of ECB]
Members of ECB/ESCB General Council (with alternatives where necessary
Chairs of
EBA, EIOPA
& ESMA
European
Commission
Macro-prudential
supervision + +
Information on micro-prudential
development
Early risk warning
European Supervisory Authorities (ESAs)
European Banking
Authority
(EBA)
European
Insurance
Occupational
Pension Authority
(EIOPA)
European
Securities &
Markets Authority
(ESMA)
Micro-prudential
regulation & supervision
National
Banking
Supervisors
National Insurance
Supervisors
National Securities
Supervisors

4. European Supervisory Authorities (ESAs)
Ensuring that a single set of harmonised ‘technical implementation standards’ and consistent supervisory practices are applied by national supervisors
Ensuring a common supervisory culture and consistent supervisory practices
“Hardening” of soft law (implementation and enforcement)
Adoption into domestic/regional legal order
Benchmarks in international assessments (IMF/World Bank)
Market/reputational sanctions: cost of capital; signalling
Defensive self-regulation
  Collecting micro-prudential information
Ensuring consistent application of EU rules, and resolving disputes in cases such as the manifest breach of EU law or ESA standards and disagreements between national supervisors or within a college of supervisors 4

5. Legal basis
Article 114 TFEU as the legal basis for the establishment of bodies that are vested with responsibilities for contributing to the harmonisation process and facilitating uniform implementation by MSs (Case C-66/04, C-217/04)
Actually and objectively apparent from the legal act creating the body in question that its purpose is to improve the conditions for the establishment and functioning of the internal market
Tasks conferred on such a body must be closely linked to the subject-matter of the relevant harmonizing legislation

6. The ESFS/ESAs/ESRB: subsidiarity and proportionality
 “Effective macro-prudential oversight of the Community financial system cannot be sufficiently achieved by the Member States because of the integration of the European financial markets” (ESRB Regulation, rec 20)
Subsidiarity as a basis for managing relations between ESFS/ESRB/ESAs and MS systemic risk oversight bodies & supervisors

7. 4/23/2019

8. The ESAs
ESAs devise standards in areas specified by EU legislation (delegation)
No general mandate to devise code/standards
Level 1 – Directives/Regulations provide Principles
Level 2 – Delegated acts may involve Commission/EP/Council
Level 3 – ESAs deliberate and adopt code/standards by QMV, and then Commission decides to endorse and can amend or substitute new code rules & standards. Council/EP may object, resulting in a review whereby the Commission may decide against ESAs.
Only Commission can adopt ESAs proposed technical implementation standards before submitting to EP/Council
4/23/2019
Prof. Dr. Kern Alexander
Seite 8

9. The ECB Objective: Price stability Standard measures: Monetary policy
Non-standard measures: Purchase government bonds
Securities market programme
Lender of last resort – Liquidity assistance (ie, Long-term Refinancing Operation)
In the crisis, an expanded list of assets acceptable as eligible collateral for refinancing operations
Enhanced credit support measures
Oversees forex operations and manages official reserves of euro area states 9

10. The ECB
But ECB is prohibited from engaging directly in prudential supervision of ‘individual financial institutions’ unless unanimous consent of EU states. Art 127 (6) TFEU. However, query ‘macro-prudential supervision’ – oversight and the assessment of risks across the financial system. 10

11. ESCB/ECB and banking supervision
The direct responsibility for banking supervision and financial stability remains with the member states/EBA, but the Treaty has assigned to the ESCB the task of “contributing to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit
institutions and the stability of the financial system”. Art 127 (5) TFEU 11

12. ESCB/ECB monitoring role
This task is mainly carried out in three ways.
(1) the ESCB monitors and assesses financial stability at the euro area/EU level. This activity complements and supports the corresponding activity at the national level, carried out by the national central banks and supervisory authorities in order to maintain financial stability in their respective country. 12

13. ESCB/ECB advises and facilitates MS banking supervision
(2) the ESCB gives advice on the design and review of regulatory and
supervisory requirements for financial institutions. Much of this advice is
provided through the ECB's participation in the relevant international and
European regulatory and supervisory bodies, such as the Basel Committee, the European Banking Committee and the European Banking Authority
(3) the ECB promotes cooperation between central banks and supervisory authorities on issues of common interest (e.g. payment system oversight, financial crisis management).
These activities are carried out with the assistance of the Banking Supervision Committee (one of the ESCB committees, which brings together experts from the EU central banks and supervisory authorities) 13

14. The ESCB/ECB may regulate infrastructure
‘the ECB and national central banks may provide facilities, and the ECB may make regulations, to ensure the efficient and sound clearing and payment systems within the Community and with other countries.´ Art 127 (2) TFEU – 4th indent ECB and NCBs have responsibility for regulating clearing, settlement and payment systems 14

15. The ECB & ESAs – some issues
 Liquidity operations affect prudential operation of banks?
Does price stability objective sometimes clash with financial stability objectives?
In confederation of states with fiscal policy controlled by member states should the ECB have a role to play in macro-prudential regulation or supervision. 15

16. The ECB – summary
  History of monetary union provides a backdrop for evolution of ECB powers and evolution of ESCB.
ECB powers mainly focused on price stability and payment systems, but growing use of competence for clearing and settlement systems.
ECB & ESCB powers not formally enhanced by Lisbon Treaty
Although prevented from prudential supervision without unanimous EU state support, growing importance of macro prudential supervision may bring its full powers to the fore. 16

17. The European Systemic Risk Board: organizational structure
General Board, Steering Committee and Secretariat; supported by an Advisory Technical Committee
 General Board: decision making body of the ESRB; 65 voting & non-voting members
 Voting members
governors of national central banks
president and the vice-president of ECB
European Commission representative
Chairpersons of the three ESAs
 One-member, one-vote; simple majority (2/3 for public warning /recommendation)
Chair/vice-chair
 Non-voting members
MS competent authorities
president of the Economic and Financial Committee
Duty of impartiality
Too big? Too dominated by central bankers? Steering committee and non-eurozone representation?

18. Legal basis and ESRB mission
“The ESRB shall be responsible for the macro-prudential oversight of the financial system within the Community in order to prevent or mitigate systemic risks within the financial system, so as to avoid episodes of widespread financial distress, contribute to a smooth functioning of the Internal Market and ensure a sustainable contribution of the financial sector to economic growth” (ESRB Regulation, art 3)
Tasks conferred on the ESRB must be undertaken for the purpose of discharging overarching responsibilities with respect to macro-prudential oversight and containment of systemic risk
“Macro-prudential”/”systemic risk” and existing EU law – can the link between subject-matter of the harmonizing laws and the tasks delegated to the ESRB be established?
Stability and soundness as pre-requisites for the smooth operation of any financial market
 ESRB within the room for innovation in harmonization techniques that article 114 provides

19. ESRB: legal status, delegated powers and Treaty basis: the issues outlined
Regulation under TFEU, article 114 as a body without legal personality and with no binding powers (“soft”)
Flexible
“common innovative framework for financial supervision” ... "wide scope and the sensitivity of its missions" (European Commission)
Can a body without legal personality/binding powers have impact?
Financial Stability Board comparison
If not taken seriously, system fundamentally flawed
But is a “powerful” informal body compatible with EU law/ what are the implications for institutional relations and governance?

20. ESRB’s soft law approach not new in EU financial policy
Prior to ESFS
Soft law and soft methods in the non-binding guidance issued by the Lamfalussy committees (CESR, CEBS & CEIOPS)
ECB non-binding recommendations
ESCB opinions and recommendations
“Soft” enforcement: peer reviews, mediation, high level principles, risk-based processes
New arrangements for oversight of systemic risk
ESRB – an “unprecedented” reputational body with no binding powers
Key element of framework for macro-and micro-prudential supervision
But presents legal, political, practical challenges

21. ESRB warnings and recommendations: hard-edged soft power
Will the ESRB establish a reputation for competence by “getting it right”? Reputation
 Will its warnings be taken seriously? Credibility
 Compliance pull: reputation but strengthened by availability of hard enforcement powers in system of which ESRB is a part; this has strengths but also potential weaknesses
 Warnings/recommendations to Community, MSs, ESAs, MS CAs (but not banks/financial firms)
 Comply or explain; reference to Council/ESA
 Publication of warnings/recommendations
 ESA obliged to co-operate, ensure follow up and take the “utmost account” of ESRB pronouncements
 MS CA liaison with ESA
Warning → emergency situation → ESA decision

22. ESRB warnings and recommendations: hard-edged soft power
“It is true that the ESRB will have influence rather than power, and that its effectiveness will, in the long run, depend on its credibility, but it would be a mistake to underestimate the extent of the ESRB’s potential to trigger real effects” (UK Treasury Committee)
 Reputational damage by association
 Important for ESRB that the ESAs be established on secure legal footing and political sensitivities (fiscal sovereignty) smoothed
Repercussions for ESRB where associated with an action by a supervisor that is the subject of a legal challenge

23. The ESRB as a informal body without precedent
ESRB: will lack of legal personality make it harder to maintain an appropriate distance?
Will ESRB lack of legal personality limit its ability to obtain confidential information from ESAs, MSs, and firms?
ESRB structure as an infringement of the “spirit” behind strict limits on the powers that can be conferred on regulatory agencies in the current Community legal order?
Governance and accountability
Adequacy of an annual reporting requirement?
Significance of duty to seek advice from private-sector stakeholders “where appropriate”?

24. ESRB: a mandate with an uncertain scope?
 “Systemic risk” – merits of an express legal definition in EU law?
G10 (2001)
the risk that an event will trigger a loss of economic value or confidence in, and attendant increases in uncertainty about, a substantial portion of the financial system that is serious enough to quite probably have significant adverse effects on the real economy. Systemic risk events can be sudden and unexpected, or the likelihood of their occurrence can build up through time in the absence of appropriate policy responses. The adverse real economic effects from systemic problems are generally seen as arising from disruptions to the payment system, to credit flows, and from the destruction of asset values.’
Currently no generally accepted legal definition
Nor do economists agree on its definition, how to measure it, or on the regulatory measures that are necessary to combat it
Risks inherent in attempting to define it in law – too restrictive given its capacity to evolve and emerge in new forms/too open-textured to be justiciable
But important for the ESRB itself to concretise its role

25. ESRB: building credibility? academic critiques
 Central bankers not legitimate politically for making decisions that involve important trade-offs between political and economic objectives and that such decisions should be left with finance ministries and other elected officials (Buiter 2011)
Lack of diversity/unwieldy size (Sibert 2010)
Technical competence re systemic risk (Treasury Committee/Buiter 2010)
And also re interpretation of data at both the micro and macro-levels (Treasury Committee/Danielsson 2010)
Price stability and financial stability objectives pull in opposite directions (Buiter 2011) – express coordination with ECB?

26. The future ESFS
From De Larosière Report to the EU Commission proposed Regulations.
On the micro-prudential side: the European Supervisory Authorities (ESAs).
Consists of 3 ESAs responsible for banking, insurance and securities respectively and Joint Committee and Board of Appeal.
On the macroprudential side, a European Systemic Risk Board (ESRB) is established.
Composed of EU central bank governors, including the ECB President, the chairpersons of the ESAs, a representative the European Commission, as well as representatives of national supervisory authorities and the Chair of the EFC (the latter two categories without voting rights). Macroprudential supervisory role (no enforcement), not regulatory role.
Is the ESRB’s responsibilities, functions and powers adequate to address macro-prudential risks?
How should ESRB coordinate with ECB and ESAs?
On 25 February high-level group on financial supervision in the EU issued a report, the aim of which, as summarised by Mr Jacques de Larosière.
Drawing on this report, the European Commission issued a Communication on with concrete proposals for reform. For the most part, these proposals were approved and confirmed by the ECOFIN and European Council conclusions in June Importantly, the new financial stability architecture will rest on two new bodies (without legal personality)
On the microprudential, the European System of Financial Supervisors (ESFS) will as act an operational of national prudential supervisors, the latter remaining responsible for the day-to-day supervision of individual firms. The ESFS will consist in the current Level 3 Committees of supervisors, which will be transformed into new European Supervisory Authorities (ESAs) responsible for banking, insurance and securities respectively.
On the macroprudential side, a European Systemic Risk Board (ESRB) will be established. It will be composed of EU central bank governors, including the ECB President, the chairpersons of the ESAs, a representative the European Commission, as well as representatives of national supervisory authorities and the Chair of the EFC (the latter two without voting rights). Whenever the subject discussed justifies the presence of insurance and securities supervisors, the central bank Governor could choose to be represented by the Head of the appropriate national supervisory authority.
The ECB will provide analytical, statistical, administrative and logistical support to the ESRB. The ESRB will be “an independent macro-prudential body covering all financial sectors”: it will collect and analyse all relevant information, identify and assess risks to financial stability in the EU, prioritise these risks, issue risk warnings and recommendations, and follow-up on the implementation on these recommendations by public authorities. The European Council has charged the European Commission with bringing forward, by early autumn 2009 at the latest, the legislative proposals to put in place the new framework for EU supervision, which shall be fully in place in the course of 2010. 26 26 26 26

27. Conclusion
ESFS adapting to changing market structures Effective macro and micro prudential regulation and supervision requires involvement of central banks and supervisors (ESAs/ESRB and ESCB/ECB) ECB role constrained by TFEU to macro-prudential oversight & LOLR, not ‘supervision’ Do macro-prudential risks justify enhanced powers for ESRB? How should the new triangular ESAs/ESCB-ECB/ESRB be managed in the future?

28. Diagram source: UK Treasury, Prof. Dr. Kern Alexander
ESFS
4/23/2019
Diagram source: UK Treasury, Prof. Dr. Kern Alexander

29.
Prof. Kern Alexander