Short-selling ban promotes debate
On 25 August, Italy and Spain announced they were extending their short-selling bans until September 30 while the French ban will remain in place indefinitely. The Belgian regulator noted that it’s prohibit on short-selling has no end-date but said it would consider lifting its ban as soon as market conditions allow. Similarly, the European Markets and Securities Authority (ESMA), which is coordinating these actions, noted that it will be monitoring the functioning of markets closely in the coming month and will continue considering possible actions which might be taken to contribute to orderly functioning markets . The extended bans will be reviewed by ESMA at the end of September.
Given the lively debates currently taking place on the merits of the short-selling ban, the current legislative proposals on short-selling, which are progressing its way slowly through the EU policy process, are under intense scrutiny. Firms and industrial bodies have an opportunity to participate constructively in these debates, and help shape the future regime on short-selling which could have significant implications for the financial markets.
The EU Council agreed a draft Regulation to harmonise rules for short-selling securities and certain aspects of credit default swaps (CDS) in May. The proposal introduces common EU transparency requirements and harmonises the powers that regulators may use in exceptional situations where a serious threat to financial stability exists. The draft Regulation applies to all financial instruments admitted to trading on an EU trading venue and broadly follows the European Commission’s proposal in September 2010 which focused on following areas:
- increasing transparency of shorted trades
- enhancing powers for national regulators and ESMA to intervene in a consistent and coordinated fashion in volatile markets to restrict or ban short selling
- reducing settlement risk created by naked short-selling through buy-in requirements within a prescribed timeframe, and
- banning naked short selling of CDS on government bonds.
The European Parliament takes a more strident view on short-selling restrictions, calling for a ban on uncovered CDS on sovereign debt and an effective prohibition of naked short selling of securities in the EU. Parliament proposes to clamp down on trading in CDS related to sovereign debt unless the investor has taken a long position in the underlying debt or an equivalent pool of assets.
In terms of the institutional dynamics underpinning the new short-selling regime, Michel Barnier, Commissioner for Internal Market and Services, recently reiterated that ESMA has a central role to play in ensuring that a Europe-wide approach to short-selling is brought forward, in the interest of preserving market integrity and financial stability across the single market. Barnier also called on the European Parliament and the Council to “quickly conclude” the negotiations on the short-selling proposals, so the Commission can put in place a robust legislative framework to avoid confusion and regulatory arbitrage in the future and help operationalise procedures around short-selling.
Enhancing supervisors’ liability
Supervisors have borne their share of criticism for the financial crisis. A new ECB working paper argues that enhancing supervisory liability is therefore justified, especially in cases of gross negligence or regulatory capture. Supervisors fearing possible litigation may not freely exercise their discretionary powers or take prompt and decisive action. Ensuring supervisors have an appropriate level of liability protection while enabling them to do their jobs requires a fine balancing act.
Europe’s current liability framework for supervisors is weak and fragmented and the ECB believes it needs to be reviewed, especially in the aftermath of the financial crisis. While most jurisdictions apply a gross negligence standard of liability to financial supervisors, in some countries (e.g. the UK and Ireland) the standard is acting in bad faith. Even where supervisors are bound by normal civil liability rules and where no statutory immunities apply (e.g. France, Greece, Italy and the Netherlands), European courts have been “resourceful” in protecting them from third party liability. For example, in Germany, the legislature or court has explicitly stated that supervisors owe their duties to the public at large rather than to individual depositors. Therefore, in the absence of a specific legal obligation to protect individual interests, financial supervisors cannot be held liable for losses which investors or depositors may suffer as a result of the supervisors’ failures.
Gradual convergence towards common standards of supervisory liability in the interests of reducing the risk of regulatory competition between regimes and promoting the development of a truly single financial market may offer a way forward. However, legal convergence is unlikely to happen quickly, given the difficulties of harmonising the substantive law of tort across jurisdictions.
To accelerate convergence of supervisory practices, the ECB recommends introducing a European Financial Supervisor with responsibility for policing the implementation of agreed standards of liability and supervision across the EU. Alternatively, the current institutional architecture could suffice, if the legal remit of the newly established European Supervisory Authorities (ESAs) was expanded. The supervisory powers of the ESAs (EBA, ESMA and EIOPA) are limited to specific cases where the national supervisor has consistently failed to act in response to a financial institution’s breach of EU regulations. The ESAs already have a common Board of Appeals, which will likely give them a greater role in promoting common supervisory standards in EU law-based tasks. The Board of Appeal and the ESAs influence the development of common liability standards at the national level or ultimately in EU law. The ECB believes it may make sense for them to be responsible for promoting common liability standards as well. In the medium to long term, this approach might result in a convergence of the national law remedies for dealing with national supervisors which have failed in their supervisory duties, or even harmonised legislation at the EU level.
Bermuda, Japan and Switzerland meet equivalence criteria under Solvency II but more work required
Bermuda, Japan and Switzerland are largely on course to meet standards under the Solvency II regime, according to equivalence assessments released by the European Insurance and Occupational Pensions Authority (EIOPA). However, all three countries need to make improvements in some areas to ensure their regimes provide a similar level of policyholder and beneficiary protection than Solvency II.
In relation to reinsurance activities (Article 172), all three countries passed EIOPA’s assessment criteria. However, Bermuda’s regime needs considerable strengthening in the following areas to ensure full equivalence with Solvency II:
- requirements for key functions
- independence of internal audit
- outsourcing and public disclosure, and
- regulatory approval for business change.
Switzerland’s public disclosure requirements are not as extensive as those under Solvency II, and EIOPA urged the Swiss regulator to require insurers to put in place a compliance function and internal audit function to match Solvency II provisions. For the Japanese’s regime, EIOPA noted that the regulator allowed its insurers to pursue “incidental non-insurance business” to an extent which is not consistent with the general principles embedded in Solvency II.
Bermuda and Switzerland were also assessed in relation to Article 227, which enables insurers to take into account the domestic calculation of capital requirements rather than using Solvency II criteria. EIOPA found that Bermuda met the criteria for equivalence under Article 227 for most insurance classes, while Switzerland’s regime for capital calculation was deemed fully equivalent, with no conditions.
Finally, group supervision (Article 260) in Bermuda and Switzerland was tested by the European insurance regulator, where equivalence would mean that EEA supervisors would rely on the group supervision of that third country. The powers and responsibilities and scope of its group supervision were deemed equivalent with Solvency II requirements in both jurisdictions. However, in relation to provisions around the exchange of information with other supervisory authorities (Principle 9), EIOPA called on Bermuda to establish supervisory colleges and dispute-solving mechanisms. It also noted that Bermuda needs to develop legally binding criteria on business change situations that require regulatory approval. Finally, while the Swiss regime is broadly equivalent to Solvency II, EIOPA suggests the need to introduce enhanced public disclosure requirements around corporate governance.
In a recent working paper, the IMF highlighted the importance of responsible determination of equivalent jurisdictions by the European Commission. In particularly, responsible equivalence assessment should address leakage problems, where insurers lower their capital charges by using reinsurers in jurisdictions where solvency standards are deemed equivalent but are in effect non-equivalent. EIOPA invites market participants and interested parties to provide information on relevant aspects of the supervisory practices and insurance regulatory regimes in all three countries. The deadline for responding to the consultation is 23 September 2011.