After the financial crisis erupted in full in September 2008, governments and financial authorities in the EU realised that they had created a “single market” for the free cross-border movement of financial services and capital in the EU, but no cross-border supervision and mechanisms to deal with EU-wide financial crises and contagion among EU banks and financial markets. A structure of increased EU-level supervision was created with three European Supervisory Authorities (ESAs).
These ESAs coordinated micro-prudential, i.e. firm-related, supervision in the EU, in relation to banks (EBA: European Banking Authority), financial markets (ESMA: European Securities and Markets Authority), and insurance companies and pension funds (EIOPA: European Insurance and Occupational Pensions Authority). The European Central Bank (ECB) is responsible for the supervision of large and systemic banks in countries participating in the Banking Union (Euro-zone) under the Single Supervisory Mechanism since November 2014. In addition, macro-prudential supervision, which keeps an overview on the entire EU financial system, has been coordinated without executive powers by the European Systemic Risk Board (ESRB).
However, the national supervisors still hold a good deal of decision-making power in these ESAs, as they sit on the ESAs’ decision-making boards, thereby being able to protect their own domestic financial industries. The ESAs had hardly any direct supervisory power, but their main goal was to promote the uniform national supervision of EU financial laws. There have been quite a few problems with the functioning and effectiveness of these ESAs, coupled with fears they would not be able to manage (new) challenges, while also struggling with tight budgets. Weaker supervision and enforcement was used by some national supervisors (e.g. Spain, UK) to provide competitive advantages to the financial sector in their respective country. This could result in growing risks of financial instability with spill-over effects for the rest of the EU.
On 20 September 2017, the European Commission (EC) published a proposal to change 13 different EU financial laws to strengthen the mandate of the ESAs. Overall, this is part of creating a “Financial Union” – comprising both the Banking Union and the Capital Markets Union – by 2019. The EC would like these amendments to be approved before the election of a new European Parliament and Commission in May 2019.
Key features of the proposal
- Stronger coordination, uniformity, and convergence of supervision across the EU, e.g. by increasing investigation mechanisms and guidelines on how market players must implement particular EU financial laws.
- Improved decision-making governance and funding of the ESAs, e.g. by creating a more independent executive board that aims at EU-wide decision-making (rather than a lowest common denominator of national interests), and partial funding directly from the supervised financial firms.
- Extended direct supervision by ESMA of particular capital market sectors, including prospectuses, benchmarks (indices) and central counterparties (CCPs guaranteeing derivatives trading);
- Making macro-prudential supervision more efficient through institutional re-arrangements at the ESRB;
- Integrating environmental and social sustainability into financial supervision by giving the ESAs a new mandate to monitor how financial firms identify, report and address environmental, social and governance (ESG) risks and take ESG factors into account, as stipulated by a range of EU financial laws (e.g. Institutions for Occupational Retirement Provision Directive (IORP II).
- Promoting the potential and integrity of FinTech (technological innovations in the financial sector) so that supervisors acknowledge developments and are able to address new challenges (e.g. cybersecurity);
- Reassessing relations with supervisory authorities in third countries to avoid financial risks from financial firms from or in third countries.
The fact that the ESAs would receive a new mandate to supervise how ESG risks and ESG factors are being integrated by financial firms (see point 5 above) was less expected. By providing such a mandate, supervisors can pose questions to banks, insurance companies, etc. about how this is being carried out, without the necessity of EU laws having to be changed to integrate ESG obligations for those particular financial companies. This means that all (28, or later 27) national supervisory authorities for banks, insurance companies, pension funds and financial markets will need to implement ways to meet this new mandate. In practice, banks, insurance companies, pension funds, etc. all over the EU should start feeling the pressure by their respective supervisors. This would also apply to the ECB in its capacity as a single European banking supervisor, as it has to abide by the supervisory methods that have been stipulated by EBA. In addition, ESAs can provide guidance on how sustainability considerations can be effectively embodied in relevant (new) EU financial legislation, and promote coherent implementation of such rules upon adoption. In this way, the EC hopes that ESAs will “play an important role in creating a regulatory and supervisory framework that supports mobilising and orienting private capital flows towards sustainable investments while ensuring financial stability.”
The implementation of this new mandate will be a challenge, since many supervisors are not yet familiar with how social and environmental sustainability factors are linked to the financial sector (so far, EU legal texts do not provide a definition of ESG ), let alone how they could pose risks to financial firms (e.g. disinvestment from oil companies could result in their shares becoming “stranded assets”).