Earlier this month, the European Commission proposed that the European Central Bank be entrusted with supervisory powers over the eurozone’s banks. Giuliano G. Castellano argues that this move reaffirms the necessity to establish an EU-wide, or supranational, supervisory structure over European financial markets (and not only the banking sector) that is detached from the national interests of member states.
During the last decades the creation of a single market for financial services has pushed EU policymakers to primarily focus on the adoption of new, harmonised provisions in pursuit of creating a level playing field where capitals and services freely circulate. This framework for the governance of financial markets– i.e. the institutional structure entrusted with the power to draft and apply such rules – developed and adapted accordingly by prioritising the creation of a rule-making institutional structure at the supranational level able to carry on the ambitious agenda of EU policy makers and leaving the oversight of markets’ participants, and consequently the application of EU financial laws, to national authorities.
In the aftermath of the financial crisis a higher level of coordination in supervising financial markets in Europe required more explicit structural reform. To this end, the European System of Financial Supervisors (ESFS), composed of three European Supervisory Authorities (ESAs) has been established and operates as of January 2011. Although the ESAs represent a first step towards a supranational European supervisory structure, their institutional capability appears to be constrained within the boundaries of a legitimacy that depicts them as mere harmonising devices, not as fully operative, supranational supervisors with direct powers over markets participants. The recent proposal from the European Commission to entrust the European Central Bank with supervisory powers over individual banks and credit institutions operating in the Eurozone reaffirms the need to establish a supranational supervisory structure detached from national interests. Nonetheless the proposal focuses exclusively on the creation of a ‘banking union’, while capital markets and the insurance sector would not be covered by the proposal.
In financial markets, the European Commission – within its mandate and in cooperation with member states – defines the ‘rules of the game’ acting as a prime, centralised regulator. Alongside, supervisory authorities of twenty-seven countries cooperate under different coordination mechanisms. Notably, between 2001 and 2004 three committees were established to support the rule making activity of the European Commission. A coordinated application of EU laws was primarily ensured by a supervisory action conducted by ‘colleges of supervisors’, which are networks of national supervisors created ad hoc to oversee specific cross-border entities and operations within the European market. The recent reform has replaced the three committees with the ESAs – i.e. European Banking Authority (EBA), European Securities and Markets Authority (ESMA), and European Insurance and Occupational Pensions Authority (EIOPA) – and has straightened the role of colleges of supervisors. The ESAs primary task is, in fact, to coordinate the supervisory action among national authorities and direct the activities of ‘colleges of supervisors’ in dealing with cross-border entities and operations with limited direct powers over markets participants.
The new architectural framework appears to reinforce existing multi-layered governance apparatus built upon a de facto separation between rule-making powers, held at the supranational level, and supervisory activities over individual entities and operations, carried out in a decentralised fashion by a series of network-like structures. The new ESAs are granted legal personality and legitimacy under Article 114 of the Treaty on the Functioning of the European Union (TFEU). The interpretation provided by the European Court of Justice of Article 114 allows European institutions to establish new authorities, as long as they are devices to ensure the ‘approximation of laws’ within the single market. Therefore, under the current legal framework, the soundness of European financial markets is ensured by considering financial supervision over market participants as an ancillary task pursued to achieve the overreaching goal of creating a single market.
Nonetheless, the transnational dimension of the current economic crisis has proved that a substantial degree of integration among markets, financial entities, and economies has already been realised. In this scenario, it is worth asking whether a European architectural framework to effectively ensure market stability and soundness wouldn’t require the direct involvement of supranational, independent institutions not only to define the rules but also to conduct supervisory tasks over financial entities and operations affecting the European market and ultimately the European economy.
Conversely, the new architecture appears to strengthen the separation between rule-making and supervisory activities, which in turn translates into a double-standard approach towards financial markets revealing potential inconsistencies between the architectural structure and the regulatory approach adopted. The relationships between regulatory approaches and the institutional framework have been studied in our recent paper, which understands governance models as a pair of two variables: regulatory approach (defined in terms of invasiveness) and architectural framework (defined in term of centralisation).
Inconsistencies and regulatory failures might arise when the approach adopted to define the rules of the game does not match with the architectural framework entrusted with the power to apply it. The current European financial markets governance still presents such risk. On the one hand, a supranational central regulator enacts increasingly more detailed and stringent rules for banks, insurance and investment firms – clearly demonstrated by the voluminous body of directives enacted in the last decades. On the other hand, the enforcement of such rules is still mandated to a decentralised set of national supervisors whose economic and political interests might lead to a supervisory action not necessarily in line with the objectives envisaged by EU policy makers. As a consequence, in between the two levels, the ESAs have a small window to operate. Therefore a truly harmonised application of centrally defined and increasingly stringent rules appears to still be a goal to be reached.
A more consistent governance action in EU financial markets would aim at aligning the architectural framework with the chosen regulatory approach by establishing a supranational supervisory structure that, in cooperation with national authorities, directly supervises financial entities and operations impacting the European market. The model adopted to govern EU competition law reveals that this is a feasible option, when the Treaty provides EU institutions with legitimacy to directly oversee markets participants. Even more, the recent European Commission proposal to create Single Supervisory Mechanism (SSM) is based on Article 127(6) TFEU, which allows the Council, acting unanimously, to confer supervisory powers on the ECB over credit institutions. In conclusion, to ensure a higher level of consistency in the apparatus governing financial markets, and not only the banking sector, a reform of the Treaty might be required. Of course this became an additional item on the present EU political debate, already heated by the recent Commission proposal to enact provisions already contained in the Treaty.
Note: This article gives the views of the author, and not the position of EUROPP – European Politics and Policy, nor of the London School of Economics.
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Giuliano G. Castellano – LSE Law Department, Law and Financial Markets Project
Giuliano G. Castellano is an LSE Fellow in Law, and part of the LSE’s Law and Financial Markets Project. He has taught and conducted his research in Bocconi University (Milan, Italy), Chicago-Kent College of Law (Chicago, IL, USA), Institute for Advanced Study of Pavia (Italy), Ecole polytechnique of Paris, and the University of Oxford (CSLS) in the fields of Comparative Law, Financial Markets Regulation, International Finance Law, Law and Economics, and Risk Regulation. He is a Research Associate at the Ecole Polytechnique (Preg/CRG) in Paris, where he collaborates on projects related to different regulatory matters. He serves as member of the Italian Delegation at the United Nations Commission for International Trade Law (UNCITRAL), on security interests.