Financial Reform Watch

The European Commission yesterday put forward its framework proposal on Financial Supervision in Europe. The proposal covers a set of far-reaching reforms to the current architecture of supervisory committees, with the creation of a new European Systemic Risk Council (ESRC) and European System of Financial Supervisors (ESFS), composed of new European Supervisory Authorities. Legislation to embody these proposals will follow in the autumn and will thus be finalized under the leadership of new Commissioners who will be appointed during the summer.

With this initiative, the Commission is responding to the weaknesses identified during the financial crisis as well as to the G20 call to take action to build a stronger, more globally consistent, regulatory and supervisory system for financial services. The proposed financial supervision package involves two key elements.

• European Systemic Risk Council (ESRC)—The ESRC would monitor and assess risks to the stability of the financial system as a whole ("macro-prudential supervision"). It would provide early warning of systemic risks that may be building up, and, where necessary, recommend actions to deal with these risks. The creation of the ESRC would address one of the fundamental weaknesses highlighted by this crisis, which is the exposure of the financial system to interconnected, complex, sectoral and cross-sectoral systemic risks.
• European System of Financial Supervisors (ESFS)—The ESFS would supervise individual financial institutions ("micro-prudential supervision"), consisting of a robust network of national financial supervisors working in tandem with new European Supervisory Authorities, which would be created by the transformation of existing Committees for the banking, securities, and insurance and occupational pensions sectors.

Commenting on the European Commission’s communication on financial supervision released today, the Party of European Socialists’ (PES) President Poul Nyrup Rasmussen said:

“The real test will come when the European Commission presents its detailed proposals. The European Commission must continue to remain faithful to de Larosière’s recommendations. They must resist the inevitable pressure from member states to water them down.”

Meanwhile, the Greens in the European Parliament voiced concerns, issuing a statement:

"The proposed measures for financial supervision reform are inadequate. To announce further cooperation and mediation of national regulators through a European System of Financial Supervisors is to promise more of the same. Greens call for a fundamental overhaul of the proposals, based around a central European supervisory authority with real regulatory teeth."

The de Larosière Group, the Commission, and other stakeholders have in fact previously discussed the benefits of creating a central European supervisory authority but abandoned the idea, mainly because of lack of political support at the Member State level. Many, however, view that such a central supervisory function is truly required for the EU’s internal market to function properly.

There is an ongoing, parallel debate in the United States. The US Treasury has begun leaking aspects of its proposed financial reform plans to the media, even though the department does not plan to release any official proposals until mid-June. The Obama administration’s first trial balloon has been the concept of creating a new, single regulator to oversee the entire banking industry. Currently, a multitude of entities regulates the sector, including the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision. The influential Chairman of the House Financial Services Committee Barney Frank (D-MA) immediately shot down the notion of a single regulator, telling a CNBC interviewer, “The suggestion that we’re going to get to a unilateral bank regulator, something equivalent to the Financial Services Authority, is simply wrong.”

Frank and his Senate counterpart, Banking Committee Chairman Chris Dodd (D-CT), have also expressed doubts about putting the Federal Reserve in charge of regulating systemic risk, which is another of the administration’s rumored proposals. The House Financial Services Committee is scheduled to begin hearings on regulatory reform on 10 June and aims to produce legislation by the end of the month. While the major banking and financial services organizations are offering input to the administration and Congress, many individual stakeholders seem to be withholding judgment until more details emerge.