Including updates on single supervisory plans for the Eurozone and Libor reform


EC propose transferring supervisory powers to the ECB

Proposals from the European Commission (EC) would give sweeping powers to the European Central Bank (ECB) in potentially the biggest shake-up in financial supervision since the creation of the Federal Reserve System in the United States almost a hundred years ago.

More than 6,000 banks in the Eurozone would be subject to prudential supervision by the ECB from 1 January 2014; the supervision of systemically large banks and those relying on government support would be phased-in a year earlier. Not just banks: bank-led financial conglomerates (including bancassurers) and financial holding companies would fall within ECB’s purview from next year.

The ECB would be responsible for all aspects of prudential supervision--from authorisation, ongoing supervision, early intervention, to the withdrawal of bank licences, where appropriate. It would assume key powers from national prudential supervisors, including national supervisory discretions, such as the imposition of higher capital and liquidity buffers when necessary to address specific systemic risks at the national level. It would become both ‘home’ and ‘host’ supervisor for banks operating cross-border in the Eurozone. It would have power to access a bank’s corporate governance and risks management processes and systems to ensure to ensure it meets with best practice standards.

Eurozone supervisors would become ECB ‘agents’ tasked with ongoing supervision at the coalface but subject to ECB rulings. The ECB would be able to intervene directly with any bank in the Eurozone. National supervisors would only retain primary responsibility for protecting consumers and preventing financial crime at the national level.

So, at a time when the ECB is assuming more and more influence over macro-prudential supervision, under this proposal, it would also assume direct micro-prudential supervision for all Eurozone banks. It is not totally clear from the EC’s proposals how the ECB, the body providing the secretariat to the European Systemic Risk Board, and the ECB, micro-prudential supervisor for the Eurozone, would be configured and inter-act, although the proposals do stipulate the segregation of the ECB’s supervisory responsibilities from its role in relation to conducting monetary policy. Conferring such powers on the ECB raises questions about the interaction with the European Banking Authority (EBA). According to the EC, the EBA retains all its existing powers and tasks, including the creation of a single rule book and supervisory convergence in relation to the European Union as a whole. With regards to supervisory convergence, the EC is now suggesting that the EBA be tasked with the development of a ‘single supervisory handbook’. However, an important issue is how EBA members vote going forward. Currently, decisions are taken either by qualified majority or simple majority (one person, one vote) within the EBA’s Board of Supervisors. As the ECB would take over as national ‘competent authority’ in all Eurozone member states this risks distorting EBA decision-making. Consequently, an amendment to the EBA Regulation (Regulation (EU) No 1093/2010) accompanying the ECB regulation looks to change, amongst other things, the voting modalities within the EBA, giving more powers to an independent panel. With supervision centralised under the ECB, the conditions for the direct use of the European Stability Mechanism in the recapitalisation of struggling Eurozone banks are met (with the possibility of removing the negative feedback loop between an embattled bank sector and the relevant sovereign). The expectation, therefore, is that Spanish banks may be recapitalised shortly after the new regime goes live on 1 January 2013 (assuming it is adopted as proposed). Worth noting, the ECB would also have an important role to play in the recapitalisation process too.

The EC has made it clear that the proposal on centralised supervision depends on the quick adoption of legislative proposals in key areas, such as CRD IV, bank recovery and resolution and deposit guarantee schemes. Amongst other things, with these in place, the introduction of a common deposit protection and a single bank resolution mechanism within the Eurozone - two further pillars of the concept of ‘banking union’ - will be easier to construct. The EC has urged EU lawmakers to finalise their negotiations on these texts by the end of this year, resolving key areas of contention as quickly as possible. Far easier said than done, particularly, as this proposal, itself, creates an additional threat to the institutional balance between the Council and the European Parliament which the EP is keen to maintain. The legal base used for the supervision proposal (Article 127(6) of the Treaty on the Functioning of the European Union) gives sole power to the Council to adopt (unanimously) the proposal. The European Parliament, normally the co-legislator for EU law on the financial services sector, is consulted only in this context (which, interestingly, the ECB is too). The EP that basing the new regime on this Article alone risks undermining the fourth pillar in the EMU 2.0 initiative (designed to address specific issues in the initial architecture of Economic and Monetary Union) namely increased democratic legitimacy and accountability. It therefore is suggesting that the ECB proposal and that amending the EBA Regulation are considered as a package.

This institutional conundrum parallels another concern still expressed by many observers: the questionability of combining responsibility for prudential supervision with monetary policy within the same body. Members of the ECB Board, amongst others, have recently set out to explain that there is no conflict between a price stability objective and a financial stability objective, pointing out that any threat to financial stability jeopardizes prices within the currency union, as well as the European Union more widely. Others, however, have argued that the implementation of monetary policy - through the increase or reduction of interest rates in line with economic conditions – can bring pressure on the viability of banks in times of economic stress. For example, a recent IMF working paper, drawing from well-established theoretical models, found that a dual-mandate central bank is not optimal from a welfare perspective (i.e. higher output) because of a time-inconsistency problem. The paper found that while it may be optimal for a central bank to pursue low inflation targets before a crisis, after a crisis it is better to let inflation rise, at odds with price stability, to repair debt-laden private balance sheets and achieve financial stability. However, the controversy is further underlined by the irrefutable need, even in a regime designed to avoid catastrophic bank failures, for a central bank to act as ‘lender of last resort’ when all else fails. The proposal seeks to balance these two opposing viewpoints by establishing strict segregation of activities between supervision and the conduct of monetary policy within the ECB.

Time will tell whether this is the right approach: whether other measures, such as those relating to bank recovery and resolution, sufficiently reduce ‘moral hazard’. The ancient Chinese curse says ‘may you live in interesting times’. As the four year anniversary of the Lehman Brothers collapse approaches, banks may prefer uninteresting times for a while so they can plan to re-build their businesses and plan for the future but, clearly, this latest proposal, combined with all the other legislative proposals in the pipeline, does not herald quieter times for those operating in the EU for the foreseeable future.


EC consults on LIBOR reform

The EC is seeking views on issues relevant to a possible framework for the regulation of the production and use of indices serving as benchmarks in financial and other contracts. The aim of the consultation is to identify the key issues and shortcomings in the production and use of benchmarks to assess the need for any necessary changes to the legal framework to ensure the future integrity of benchmarks.

The consultation covers a number of areas, including:
  • General information on indices and benchmarks, including their definition, the persons that produce indices and the methodologies that they use, and the purposes for which indices are used.
  • Governance and transparency arrangements concerning the calculation of benchmarks, including the use of data and the persons contributing the data.
  • The purposes and uses of benchmarks.
  • The role of private and public bodies in providing benchmarks.
  • The potential impact of the regulation of benchmarks, including the need for transitional arrangements and the international issues to be considered for any new framework for indices and benchmarks.
The consultation follows draft amendments on market manipulation in the Market Abuse Directive (MAD) II/ Regulation on 25 July 2012 to prohibit benchmark manipulation by making these criminal offences. To help inform the European Parliament’s (EP) Economic and Monetary Affairs Committee (ECON) response, lead rapporteur Arlene McCarthy MEP, is has published a short questionnaire, seeking stakeholder input, aiming to contextualise the reforms (with a response date of 17 September). It canvasses opinion on what measures should be taken to ensure integrity and quality of all benchmarks; to improve investor confidence in light of the scandal; and to increase transparency around the operation and governance of benchmarks.

In terms of next steps, the negotiations on the MAD II/MAR revisions were proceeding relatively smoothly. However, the extension of the proposals to include benchmarks will impact the timetable. The vote in ECON, which had been scheduled for 20 September, will be postponed.