Including updates on the ESA's burgeoning work load, recommendations on US dollar funding and principles on Collective Investment Schemes


Can the ESAs deliver?

Seven trade associations, including the European Banking Federation and the Alternative Investment Management Association, are concerned that the huge work load facing the European Supervisory Authorities (ESAs) could derail the momentum and jeopardise the quality of financial regulatory reform in the EU. In a joint letter to the European Commission, European Parliament and EU Council on 17 January, the trade associations indicated that the ESAs’ 2012 work programmes are unrealistic given their limited resources and that the timelines for key pieces of legislation should now be reconsidered.

2012 will be a very demanding year for the ESAs. The European Securities Markets Authority (ESMA) is required to finish drafting over 50 detailed technical standards and guidelines on the Regulation on OTC derivatives, central counterparties and trade repositories (dubbed ‘EMIR’) by 30 June 2012. It can only formally start this process after Level 1 text is adopted in EU law (i.e. printed in the Official Journal) which could be weeks (or months) away, given that final political agreement on the text is still pending (although allegedly close given the EcoFIN Council’s agreement to adjust their negotiating position at its meeting on 24 January). ESMA has also to provide technical advice to the Commission in relation to delegated acts in relation to the short-selling and credit default swaps (CDS), as well as a series of technical standards (on which a consultation paper was launched on 24 January) by 31 March 2012. The short-selling and CDS regulation will apply from 1 November 2012.

For its part, the European Banking Authority (EBA) is planning to publish over 70 regulatory technical standards, 30 implementing technical standards and 20 guidelines on the Capital Requirements Directive IV this year (CRD IV). Again, the European Parliament and EU Council are still debating the Level 1 text for CRD IV.

The European Insurance and Occupational Pensions Authority’s (EIOPA’s) work on Solvency II could continue to be hindered this year as the debate continues on some key technical changes to the Directive to be introduced through the Omnibus II Directive. These concerns were reinforced by the European Parliament's Economic and Monetary Affairs (ECON) Committee decision last week to delay a key vote on the Directive from 24 January to 21 March.

The trade associations recommend that if all the ESAs’ tasks in their 2012 work programme can’t be completed this year, the ESAs should prioritise areas and adopt a phased approach to developing implementing measures. This approach makes sense because continually delaying reforms risks creating frustration and uncertainty amongst market participants and national regulators. The delays will present problems for financial institutions as they struggle to prepare to implement complex regulations which could have far-reaching implications on their organisational and operational structures. The trade associations suggest that a more focused approach and realistic timetables would ensure that key provisions of some important regulation (such as OTC derivative reforms and capital adequacy rules)--which are key G20 initiatives essential to buffering financial stability--are implemented on time.

Significant progress has been made on drafting legislative proposals on some big ticket regulations such as CRD IV, EMIR and Markets in Financial Instruments Directive (MiFID) II in the last number of years. However, the reform process is now entering a very difficult phase where detailed technical rules and standards are being thrashed out. These rules and the accompanying implementing standards shouldn’t be rushed. The ESAs need to be given enough time and resource to achieve high quality reform, supported by appropriate and meaningful consultation with market participants. On resources, Sharon Bowles, the UK Member of the European Parliament who currently chairs ECON, stressed this week that the ‘whole strategy of the Financial Supervision Package’ will be ‘undermined’ unless the war chest of the ESAs are significantly expanded.


ESRB issues recommendations on US dollar funding and macroprudential regulation

The European Systemic Risk Board (ESRB), the EU’s macroprudential watchdog, has issued two sets of recommendations on US dollar dominated funding and macroprudential regulation. This is the first time that the ESRB has issued recommendations of this nature.

US dollar denominated funding is a cause for particular concern to the ESRB given:
  • a material mismatch in the US dollar assets and liabilities of EU banks, with short-term assets provided through wholesale funding being used to finance longer-term activities and assets
  • the volatility of US dollar funding markets since June 2011 and
  • data gaps hampering national supervisors ability to monitor any build-up of risk.
National supervisors should carefully monitor US dollar funding and liquidity risks taken by their banks, according to the ESRB. Banks should be encouraged to take necessary ex ante measures to limit excessive exposures and correct distortions in risk management. Contingency funding plans should be put in place which will force senior management to demonstrate what actions they will take to handle various levels of disruption in the supply of US dollar funds. The feasibility of these management actions should be carefully considered by all parties involved, particularly if more than one credit institution tries to undertake them concurrently. National supervisors should assess these plans collectively at the macro level. If simultaneous action by financial institutions is likely to create potential systemic risks, supervisors should consider taking mitigating actions to limit those risks and their impact the banking sector’s stability.

Effective national macroprudential policy frameworks may capture many of the ERSB’s recommendations presented above and negate the need for such calls for action in the future. However, this area is still very nascent and much work needs to be done. To lay the foundation for such reforms the ERSB has outlined the necessary conditions for effective macroprudential regulations:
  • Objective: Surprisingly, defining what macroprudential regulation actually is and what it should technically achieve is still a point of contention amongst policy makers. The ERSB recommends that the objective of macroprudential regulation should be “to safeguard of the stability of the financial system as a whole, including by strengthening the resilience of the financial system and decreasing the build up of systemic risks”.
  • Regulators’ institutional arrangements: Another sticking point in the policy making process arises from the interaction of financial stability with monetary policy, financial regulation, fiscal policy and the lender of last resort responsibilities of the central bank. In many instances these various responsibilities are split between several institutions. The ESRB doesn’t formally delineate a normative structure-- whether it should be the responsibility of a single or defused institutional structure. However, it does recommend that central banks should play a leading role in any such structure.
  • Tasks and instruments: Policy makers and academics are still grappling with designing effective tools to identify systemic risk. For example, a Bank for International Settlements’ paper outlined this month that, given current technology, macro stress tests don’t work well as early warning devices. While the ESRB doesn’t address this issue head-on, it recommends that the macroprudential authority should have power to obtain information. It believes that this is important regardless of the instruments which emerge in the future.
  • Transparency and accountability: A much less debated area of macroprudential regulation. The ESRB believes macroprudential policy decisions and their motivations should be made public in a timely manner, unless risks to financial stability may arise from doing so. The macroprudential authority should be made accountable to the national parliament.
  • Independence: A less heated area of debate as most agree with the ERSB recommendations that the macroprudential authority is at a minimum operationally independent. The ERSB also suggests that organizational and financial arrangements should not ‘jeopardize the conduct of macroprudential policy’.
As we have outlined previously (16 January, 2012; 28 November, 2011; 7 November, 2011) the whole area of macroprudential regulation is still very much a work in progress. Notwithstanding all of the practical elements mentioned above, there is still little agreement on what powers and sanctions a macroprudential regulator should have at its disposal. To achieve lasting financial stability, we need to make substantial progress in this area, before the memory of the financial crisis becomes too distant and financial market participants start to believe again in their collective infallibility.


IOSCO outline principles on Collective Investment Scheme and OTC data collection

The International Organization of Securities Commissions (IOSCO) Technical Committee has outlined some general principles regarding the suspension of redemptions for open-ended collective investment schemes (CIS). The principles can be grouped into the following categories:
  • Management of liquidity risk: CIS operators should ensure that the liquidity of their open-ended CIS allows them to meet redemption obligations and other liabilities. Before and during any investment, they should consider the liquidity of the types of instruments and assets the CIS invests in and their consistency with the overall liquidity profile of the open-ended CIS.
  • Ex-Ante disclosure to investors: The CIS operator should clearly disclose the ability to suspend redemptions in exceptional circumstances to investors prior to their investment into the CIS.
  • Criteria/reasons for the suspension: Suspension of redemptions may be justified only a) if permitted by law and in exceptional circumstances provided such suspension is exclusively in the best interest of the CIS’ unit holders, or b) if the suspension is required by law, regulation or regulators.
  • Decision to suspend: CIS operators should have the operational capability to suspend redemptions in an orderly and efficient manner. The decision to suspend should be appropriately documented, communicated to national supervisor, unit-holders and other relevant parties.
  • During the suspension: During the suspension of the redemptions, new subscriptions should not be accepted. The suspension should be regularly reviewed.
The principles are common sense but welcome. Promoting a common approach and standards across international borders will help investors assess the quality of regulation and industry practices concerning suspensions of redemptions across products from different jurisdictions.

In a separate development, on 25 January 2012, IOSCO published their final report on the OTC derivatives data that should be collected, stored and shared by trade repositories (TRs) The committees support the view that TRs, by collecting such data centrally, would provide supervisors and the market participants with ‘better and more timely information’ on OTC derivatives. This would make markets more transparent, help to prevent market abuse and promote financial stability. It also recommends the ‘expeditious development’ of a standardised Legal Entity Identifier (LEI).

The report also describes the different types of trading platform currently available for the execution of OTC derivatives transactions in IOSCO member countries and the different approaches global supervisors are taking (or envisage taking) to mandate the use of organised platforms for trading OTC derivatives.