10.  EUROPEAN BANKING AND FINANCIAL REGULATION

 

 

The European Union represents the most developed and sophisticated system of regional integration attempted in the world at this time. This is based on a Single Market in goods and services which includes a specific banking and financial services programme. This is principally founded on the recast Banking Consolidation Directive (BCD) 2006/48/EC and Markets in Financial Instruments Directive (MiFID) 2004/13/EC. The BCD will be further amended to give effect to Basel III (CRDIV) with the MiFID being replaced by a MiFID II. European integration is based on the idea of economic functionalism with the directives in the banking and financial area being based on the three core concepts of Mutual Recognition (MR), Minimum Harmonisation (MH) and Home Country Control (HCC). The objective of all of these directives is to create a common or single passport system for all financial institutions which allows them to provide services in all Member States of the EU. The EU programme is being further amended and extended as part of the EU’s post-crisis response and economic recovery policy.

 

 

 

(a)       European Union

 

The EU has been constructed incrementally through a series of international treaties beginning with the European Coal and Steel Community (ECSC) in 1951 and European Economic Community (EEC) Treaty and EURATOM Treaty in 1958. These were integrated under the Treaty on European Union Treaty 1993 in Maastricht which created the three pillars consisting of the European Community (the EEC, ECSC and EURATOM) and a new Common Foreign and Security Policy (CFSP) and Justice and Home Affairs Policy (JHAP). This was subsequently revised and extended under the Treaty of Amsterdam 1999, Treaty of Nice 2000 and Treaty of Lisbon 2007.

 

The Treaties provided for the establishment of a number of European institutions including the European Council, European Commission, European Parliament (with direct elections from June 2004) and the European Court of Justice. Banking and insurance were included within the original General Programmes produced under the EEC (and later EC) Treaty which were intended to remove all obstacles to do free movement of services and establishment through implementing directives.

 

The free movement of capital was also provided for under the EEC Treaty although a series of ‘standstill’ provisions were agreed and incorporated into the implementing directives which delayed this coming into effect the late 1980s as part of the ‘Single Market’ or ‘1992 Programme’ which was provided for under a 1985 White Paper prepared by Commission President, Jacques Delors, and the UK Commissioner Lord Cockfield.

 

(b)       European Integration

 

European integration policy is based on economic functionalism. This involves the pursuit of a narrow target objective the successful completion of which allows wider cooperation to be secured in other areas. European functional integration was initially achieved through the creation of the European Coal and Steel Community under the ECSC Treaty which was later extended to include nuclear energy and a Common Market under the EURATOM and EEC Treaties. This was further extended under the Maastricht Treaty which provided for European Monetary Union (EMU) with the additional pillars on CFSP and JHAP and then later treaties.

 

The European institutions initially attempted to agree necessary directives under a policy of full harmonisation during the 1960s and 1970s although this was unsuccessful principally due to differences in underlying laws. A more limited ‘Minimum Harmonisation’ (MH) approach was developed during the early 1980s following the famous decision in Cassis de Dijon in 1979 and a Commission Communication on the importance of the decision in securing mutual recognition in 1980. This policy was incorporated into the Commission’s White Paper in 1985 on Completing the Internal Market with supporting Treaty amendments been effected under a Single European Act 1986. Mutual recognition operates on the basis of each European Member State respecting the validity of the laws of each other provided that they comply with certain agreed minimum harmonisation (MH) standards and with supervision and compliance being secured on a home country control (HCC) basis.

 

(c)       European Banking and Financial Markets

 

A First Banking Directive (FBD) was agreed in 1975 which came into effect in 1977. This followed rejection of an earlier full draft harmonisation directive on a German-Dutch model which the other Member States could not agree to at that time. Following the decision to move from a full harmonisation to a mutual recognition (MR) approach, three major directives were adopted in the banking area in 1989 with the Second Banking Directive (SBD), Solvency Ratio Directive (SRD) and Own Funds Directive (OFD). The SRD and OFD implemented the Basel 1988 Capital Accord within Europe, with the SBD expanding the convergence of European bank regulations begun under the FBD.

 

A number of other more specific directives were adopted in such areas as consolidated (group) supervision and large (borrower) exposures with other amendments being later agreed. All of these measures were drawn together in a Banking Consolidated Directive (BCD) in 2000 which was amended and reissued as a Recast Banking Consolidated Directive in 2006 to implement Basel II within the EU. This will be amended again under a further Capital Requirements Directive (CRD IV) to give effect to Basel III. Capital requirements for banks and securities firms had already been amended under a CRD II (on large exposures, hybrid capital instruments, securitisation, crisis management and college supervision) and CRD III (dealing with trading book re-securitisation (structured finance) and remuneration).

 

The list of activities covered by the SBD included all banking and securities functions on a Continental European bank model with the sole exclusion of insurance services. A separate securities directive had to be agreed for such countries as the UK and the Netherlands which had more specialist non-bank securities firms. This led to the adoption of the Investment Services Directive (ISD) in 1993 with a supporting Capital Adequacy Directive (CAD). The ISD was substantially amended subsequently under the Markets in Financial Instruments Directive (MiFID) in 2004 and with a consultation document on a new MiFID II being issued in 2010. A series of ‘Three Generations’ of directives had also been adopted in the life (assurance) and non-life (contingent liability) insurance areas with a further Solvency II Directive to come into effect by 2013 to create a Basel II equivalent capital regime for insurance companies.

(d)       European Consolidation, Revision and Completion

 

The European banking and financial directives have since been amended on a number of occasions and then consolidated, especially with the BCD 2000 and recast BCD 2006. The European Commission has also undertaken a number of other steps to attempt to ensure the effective operation of the single markets in each of the banking, securities and insurance areas. An original Action Plan was adopted in 1977 with a Financial Services Action Plan (FSAP) in 1998. The Lamfalussy Committee examined the delays that arose in securing securities and capital market integration in 2001 with a four level approach being recommended to correct these. This was based on a series of framework principles, technical implementing measures, strengthened co-operation and effective compliance. The Lamfalussy Committee had identified the micro and macro benefits of a single financial market with five core barriers and eight overarching principles to direct reform. The Commission issued a subsequent series of Progress Reports on its completion work before the financial crisis beginning in September 2007.

 

(e)       European Crisis Response

 

The EU response to the financial crisis was initially slow and hesitant. A number of Member States, beginning with Ireland and then Germany, had adopted protective measures through increasing domestic deposit protection ceilings to assist national depositors and banks. The European institutions have since adopted a more complete response based on a general Recovery Plan in October and November 2008 (From Financial Crisis to Recovery: A European Framework for Action Com (2008) 706 final and A European Economic Recovery Plan Com (2008) 800 final). These are generally based on promoting growth and stimulating confidence in the short term and reinforcing competitiveness in the long term.

 

A number of other more specific measures have been adopted or proposed in the banking and financial areas with new directives in the areas of hedge funds and Alternative Investment Managers and Credit Rating Agencies (CRAs) as well as CRD IV (to implement Basel III) and Solvency II in the insuarance area. Deposit insurance levels have been increased and restrictions imposed on bankers’ bonuses. The Commission has been working on strengthening the supervision of cross-border groups through colleges and on ensuring effective bank resolution through the establishment of resolution funds. Communications and cross-border crisis management for banks were issued in November 2009 and on bank resolution funds in May 2010. A bank levy has been proposed and further possible transaction taxes considered.

 

The opportunity has also been taken to replace the earlier European technical committees in each of the banking, securities and insurance areas with new authorities from January 2011. This has involved establishing a European Banking Authority (EBA), a European Securities and Markets Authority (ESMA) and a European Insurance and Occupational Pensions Authority (EIOPA). These were set up as part of a larger initiative to create a European System of Financial Supervisors (ESFS) with a separate European Systemic Risk Board (ESRB) being set up to conduct macro-prudential oversight of all European markets.

 

 

Commissioner Barnier issued ‘Twelve levers to boost growth and strengthen confidence’ in April 2011. The Competition Directorate General (DG) has also issued a number of decisions on state aids and merger control especially in light of the emergency assistance provided by governments to national banks and subsequent consolidation within the financial sector.