Could the EU move to a twin peaks regulatory model post Brexit?


In March the European Commission launched a public consultation on the operation of its European Supervisory Authorities – the so-called ESAs. Created in 2010, there is one each for banking (EBA), insurance (EIOPA) and securities (Esma).

The consultation covers many issues, including governance, enforcement, supervisory convergence, direct supervisory powers, funding and supervisory architecture.

These last two are particularly important and are discussed here: the departure of the UK from the EU provides an opportunity to re-examine the structure and reform it in line with the needs of the remaining 27 member states.

Just over half a decade is perhaps too short to declare ESAs a success or a failure, but in that time financial services policy and products, and how they are delivered, have evolved hugely.

While some progress has been made in ensuring that member states play by the same rules (supervisory convergence) and that cross-sectoral co-operation between ESAs is increasingly effective; the ESAs still suffer from a dearth of resources (they depend on hybrid funding), inadequate enforcement powers, and lack of rule-making flexibility.

Segmentation into banking, insurance and re-insurance, and securities and capital markets sectors has decreasing relevance in a world where firms increasingly cross these boundaries in the production and marketing of products. Fintech and financial innovation blur the lines still more.

The ESAs were designed partly to speed up the rate at which rules could be formulated and enacted, as well as to ensure consistency of regulatory implementation across member states. Instead, a model has emerged which falls short of independence, swiftness of decision-making, and clarity of outcome (just look at the pages and pages of additional Mifid II rules).

The ESAs are still in thrall to the Commission and member states’ regulatory authorities, which share the funding. They are thus kept on a tight financial leash by both sets of stakeholders, which impacts on resources; and limited in action by their original mandates.

So what could be done to improve this?

Well, first, for the ESAs to be truly independent funding must evolve away from dependence on the Commission and member states and towards greater self-sufficiency. That means increasing the supervisory fees both from nationally regulated firms across the EU and from the institutions directly supervised at European level.

Esma currently can only charge the directly supervised entities such as credit rating agencies and trade repositories. Why not widen this to include market infrastructures or investment firms operating EU-wide as well?

Second, the sectoral distinction between the ESAs is no longer fit for purpose: it must be eliminated and the architecture over-hauled. Matters are doubly confused on the banking side where, as well as the EBA (currently located in London), there is also the Single Supervisory Mechanism (SSM) within the ECB which oversees the major euro-area credit institutions.

The SSM (which charges supervisory fees) has the power to write its own rules, creating potential duplication with the EBA. Once the UK leaves the EU it would make a lot of sense to combine both the EBA and SSM in Frankfurt. Then align this with EIOPA, also based in Frankfurt. Insurers say their sector is unique and requires a separate model; but if the Bank of England and the Prudential Regulation Authority can do it at the prudential level, why not the EU?

We are then half way to a twin peaks format. With some tweaking of responsibilities and powers, so that the merged Frankfurt entities carry out prudential supervision, similar to the PRA, then Esma (based in Paris) could be transformed into the EU conduct regulator, à la the FCA.

This has the added benefit of helping international co-operation and supervision, with third countries (including the UK in the future) having to conclude and maintain fewer Memorandum of Undertakings. The natural links between the PRA and EU prudential regulator, and the FCA and its conduct homologue, could simplify matters greatly post-Brexit and help to make a good Brexit agreement easier to achieve. A benefit for all in the long run.

Alex Merriman is a policy consultant for the WMA, now Pimfa