Thanks to Brexit: An ever-closer Union in financial supervision
Nathan de Arriba-Sellier (Leiden and Rotterdam Universities)
Three years after the referendum, the path to Brexit has proven to be a litmus test for European supervisory arrangements. In addition to the preparations led by proactive and cooperating British and European authorities, a large reform of the European law of financial supervision has recently been adopted. This reform is going to result in further centralisation of financial supervision at EU level, more proportionate regulation and the tightening of EU’s extraterritorial authority in financial supervision.
The further centralisation of supervisory powers is manifested by transfers of direct supervisory competences from NCAs to European authorities. The remit of the Single Supervisory Mechanism is going to be extended to large investment banks, of which the City is a hub. In addition, critical and third country financial benchmarks will be directly supervised by the European Securities and Markets Authority (ESMA). While there are only a few critical benchmarks administered in the EU27, the European Commission noted that, ‘the number of third country benchmarks will most likely be very large, especially after the United Kingdom has left the EU.’ The supervision of the clearing houses (CCPs), a central component of the financial system, is to be tightened by giving ESMA and European central banks a greater say.
This strengthening of EU financial supervision is mirrored by a certain amount of deregulation, in the form of more proportionate regimes. From investment firms to CCPs, benchmarks and banks, the EU legislators have introduced multiple-tiered regulatory and supervisory regimes which will alleviate the compliance burden for non-significant market actors and render the EU financial industry more competitive.
The legislators have also granted EU financial supervision a wide extraterritorial authority across financial sectors. The reform will result in a severe tightening of control over third countries financial institutions and market infrastructures to prevent supervisory arbitrage. It particularly aims at mitigating the possible costs and risks incurred by Brexit, especially if the United Kingdom were to follow a more competitive and less regulation-oriented ‘Singaporean model’ after its withdrawal. The reform introduces “comparable compliance” regimes that are stricter than the current equivalence system. This is particularly the case for CCPs, where CCPs have to consent to a strict monitoring by ESMA. The reform also enables ESMA and central banks to recommend the non-recognition of a CCP if the risks of being established in a third country are too important for EU financial stability. The non-recognition would prevent the CCP from offering clearing services to EU counterparties, unless it relocates to an EU Member State. Furthermore, the European Supervisory Authorities’ ability to foster supervisory convergence will be enhanced with regard to market actors established in third countries. The reform horizontally empowers them to monitor the regulatory, supervisory and enforcement developments taking place in third countries to ensure that equivalence decisions remain justified over time. Besides, the legislation strengthens the obligations of third countries’ systemically important banks and investment firms and reinforces their supervision. According to the new CRD V legislation, third countries financial groups will be particularly required to establish an intermediate EU parent undertaking with additional capital and liquidity, in order to ring-fence their EU activities from a risk of contagion. This mirrors the U.S. Intermediate Holding Companies regime, introduced by the Dodd-Frank Act of 2012.
The reform, however, failed to further overhaul European financial supervision where EU27 national interests were at stake. National authorities have kept the upper hand on European Supervisory Authorities, despite the risks of conflict of interest exposed by the “Danske” scandal. An attempt by the ECB to grab more regulatory powers with regards to CCPs was eventually watered down. Besides, practices of outsourcing and delegation arrangements, that may be used to escape regulatory and supervisory constrains when organized across borders, have been left untouched, despite significant risks of loss of control and conflicts of interests. They are accused of enabling the use of “empty shell” companies for the sole sake of accessing EU financial markets. Facing the opposition of asset managers and their home Member States, who have interest in promoting their national hubs post-Brexit, a provision to introduce a supranational control of outsourcing was withdrawn.
Brexit has underlined the remaining gaps in European financial supervision and is resulting in a formidable strengthening of EU supervisory capacities. It is remarkable that the more tightening aspects of the reform targeted the financial sector, not the banking sector. It is not coincidental that the financial sector is largely the stronghold of the City of London and the UK in general, whereas continental Europe enjoys a more favorable position in the banking sector. The introduction of more accommodative regimes is also supposed to support the EU financial industry in the post-Brexit era. However, Brexit has also shown that, even once the United Kingdom gone, significant hurdles will prevent the federalization of European financial supervision. These constrains explain in some part the regrettable complexity – and in some respect the confusion – of the reform. A follow-up reform might be needed in this regard, particularly if a no-deal Brexit exposes new loopholes. Nonetheless, it is clear from this reform that the United Kingdom is already and indirectly delivering, thanks to its withdrawal, what it has long resisted as an EU Member State: an ever-closer union in financial supervision.
Nathan de Arriba-Sellier is PhD researcher at the European Research Centre for Economic and Financial Governance (EURO-CEFG) of Leiden and Rotterdam Universities