Although in its early stages, European Financial Reform is rapidly developing. There are challenges unique to the European Union in terms of jurisdictional complexity that make Dodd-Frank look like a stroll in the park. Providing regulatory oversight without stepping on nationalist toes will be some trick indeed.
In spite of the obvious obstacles, the EU is moving forward. In December the European Parliament moved legislation that created the European Systemic Risk Board. The ESRB is part of the European System of Financial Supervision (ESFS), the purpose of which is to ensure the supervision of the Union’s financial system. The ESRB closely resembles the Financial Stability Oversight Council, which was created by the Dodd-Frank Act. It will be responsible for the macro-prudential oversight of the financial system within the EU in order to assist in the prevention or mitigation of systemic risks to financial stability in the EU.
This month, the European Parliament established three new European Supervisory Authorities: the European Banking Authority, the European Securities and Markets Authority, and the European Insurance and Occupational Pensions Authority. These are the guys that will be setting the technical standards for financial institutions. They will work very closely with the ESRB in laying the groundwork for the new regulatory policies. One key stipulation that the ESAs must abide by is that they must ensure that no decision impinges on the fiscal responsibilities of EU member states. I can see situations arising where a national interest and a rule issued by an ESA may be at odds. One wonders what the reconciliation process will be like.
In order for these newly established entities to be effective the EU will need to come up with joint data standards. Data standards across national supervisory bodies have long been considered a kind of Achilles’ heel for the EU. With 27 member states, it will be interesting to see how the data standards develop – I can’t get my family to agree on lunch.
What About Derivatives?
Regarding the regulation of derivatives we see the European Commission proposing rules similar to those seen in Title VII of Dodd-Frank. Through the MiFID (Markets in Financial Instruments Directive) revision proposals we see the central themes of greater transparency, central clearing and reduced operational risk clearly taking shape.
European entities will be subject to mandatory reporting of OTC derivative trades to central data centers. Very much like its US counterpart, the Swap Data Repository, the trade repository will collect position information by derivative class and publicly disseminate the information. It will be the responsibility of the European Securities and Markets Authority to govern these repositories.
Very much like in Dodd-Frank, over-the-counter derivatives that can be cleared must be cleared through central counterparties. Eligible transactions will include those that are standardized or that possess a high level of liquidity.
The European Commission’s proposal strongly promotes the use of electronic means for the timely confirmation of the terms of OTC derivatives contracts as a means of reducing operational risk. Entities should develop and maintain an organizational structure, internal controls and a reporting system suitable for the identification, assessment, control and monitoring of operational risks in market-related activities.
Prompted by the 2009 G-20 agreement that stated – “all standard OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest”, the European Commission has made it clear that it intends to stick to that time frame.
We will be watching these developments very closely.