The European Union Understanding The Regulatory Landscape

1. The European Union Understanding The Regulatory Landscape September 2010

2. Regulation in the US • Initially more wide-spread than in the EU • – ideational causes: belief in superiority of market • outcomes, distrust in state internvetion • – power cause: regulation as compromise betweenCongress and President • • Institutionalform: independentregulatoryagencies • – oversight by Congress, judicial review • – far-reachingautonomy • • Problems • – regulatory capture, iron triangles • – non-majoritarianpolitics?

3. The Current U.S. Regulatory Structure President’s Working Group on Financial Markets (1988) Securities and Exchange Com. (1934) U.S. Treasury Office of Thrift Supervision (1933)/(1989) Federal Deposit Insurance Corp. (1933) FINRA. (7/2007) National Credit Union Administration (1934)/(1979) National Association of Insurance Com. (NAIC) (1871) State Securities Com. (1911) State Banking Com. (1838) Other State Comms. State Securities Com. (1911) State Banking Com. (1838) State Insurance Com. (1850s) State Securities Com. (1911) State Banking Com. (1838) Other State Comms. State Insurance Com. (1850s) State Insurance Com. (1850s) State Banking Com. (1838) Other State Comms. CFTC (1921-22)/(1974) Federal Reserve System (1913)/(1956) ERISA Agencies (1974) ---- Dept. of Labor I.R.S. PBGC Comptroller of the Currency (1863) Insurance Banking Securities

4. The Modern Financial Conglomerate Other Affiliates Holding Company Depository Institution Insurance Company Securities Firm

5. Regulation in the US

6. Trends in European States • post WW-II: – nationalization of key economic sectors (for economic recovery and/or distrust of market) – huge variations across countries! • since 1980s: – far-reaching privatization of nationalized firms,including former „natural monopolies“(railways,telecom) – causes: • ideational/political (spread of „neoliberal“ ideas, victory of governments supporting these ideas) • normative or fiscal exhaustion of „positive“ welfare state • EU internal market program („1992“) stresses need for EU-wide regulation, COM and ECJ see nationalized firms as market distortions

7. Trends in the EU • very strong growth of legislative output in general over time • specific powers of EU – distribution narrowly confined (agriculture,regional development, research) • no welfare spending, no large-scale infrastructure projects, no defense spending, no education spending – budget strictly limited, no taxing powers – most legislative output = regulatory policy

8. Supply of regulation • Commission: – wants to increase its powers – but cannot increase its staff or budget – hence increases policy-making powers – COM also generally predisposed towards European as opposed to MS powers – protection of diffuse interests out of „collective goods“ attitude • European Parliament – similar motives – also protection of diffuse interests (citizens‘ concerns, e.g. consumer and environmental protection) • costs of rules are imposed on private firms and oftendiffused (BUT mobilization of states still possible, e.g. car industry)

9. Demand of regulation • firms • – multinational or exporting firms prefer single European • standard to multiple national standards • – also prefer stable EU solution to competitive MS dynamics • • public interestorganizations • – use EU standards to achieve their goals (faced with national stalemate) • • member states • – try to generalize their own regulatory standards • – pursuespecific objectives (e.g. financial services liberalization) • – want to provide a favorable environment for their firms • in the Europeanmarket • – avoid „time inconsistency“ -> credible commitment

10. Forms of regulation in the EU • different from the US! • hardly any independent agency – huge growth of agencies since 1990s – but mostly devoted to information gathering and exchange – e.g. EMEA: highly decentralized even with,centralized“ procedure (admission of new medical drugs to EEA area) • some direct regulation by COM (e.g.competition) • much regulatory legislation (COM, Council, EP) • rise of national regulators, European network ofregulators with COM oversight (e.g. energy, telecommunication) Assessment • normative agenda or empirical phenomenon? • institutional solutions differ fundamentally between US and EU • regulation = politically biased? • non-majoritarian institutions =unaccountable technocracies? • underestimation of political and redistributive consequences of regulation

11. Basel III: The next round of reform proposals • Implications for Bank Capital: • Three separate sets of amendments to the EU’s capital requirements directive – which implements the Basel rules on capital standards within the bloc – have surfaced since the 2008 financial turmoil. • The first two sets of amendments have been passed, and tightened capital rules in several areas – such as securitisations, large exposures and trading book risks. The third set – known as CRD (Capital Requirements Directive) IV - is being worked on, and should lead to legislative proposals in the second half of 2010. • Areas which could be covered by CRD IV could include liquidity standards, leverage ratios, measures to deal with the risks posed by systemically important institutions, and dynamic provisioning.

12. Basel III: The next round of reform proposals • Implications for Systemic Risk: • As part of a bigger overhaul of Europe’s patchy system of financial supervision, the EU plans to establish a new ‘European Systemic Risk Board’, which would warn about high-level risks to the bloc’s financial system and depend very considerably on input from central bankers within the bloc. • Final details of the legislation need to be agreed between EU member states and the European Parliament, but this is widely-expected to happen later in 2010. Whether the European Central Bank president should automatically chair the new board is one of the outstanding issues.

13. Basel III: The next round of reform proposals • Implications for Levies: • European Commission wants an EU-wide network of national bank resolution funds – to help sort out future bank failures – to be established, financed by a levy on the banking sector. • The idea has had a mixed reception, with some countries unwilling to restrict the use of bank levies in this way and keener, for example, to use them to reduce national budget deficits. But more detailed proposals on this ‘crisis management framework’ are expected from Brussels later in 2010, followed by legislation in 2011.

14. Basel III: The next round of reform proposals • Implications for Bonuses: • EU legislation, which restricts bonuses in the banking sector, was agreed in July 2010. Under this, between 40 and 60 per cent of bonuses would have to be deferred for three to five years, and half of any upfront bonus would have to be paid in shares or securities linked to the bank’s performance. • The onus is now on all 27 member states to implement these rules in their domestic laws by January 1, 2011. They are also required to impose sanctions – which can be higher capital requirements – on banks which run excessively risky remuneration policies.

15. Basel III: The next round of reform proposals • Implications for Consumer protection: • Legislative changes, beefing up deposit guarantee arrangements and investor compensation schemes, were unveiled in July 2010, and will now need approval from member states and the European Parliament. Bank depositors will be covered, in the event of a bank failure, for up to €100,000 from 2011. Under the new rules money will have to be paid out in seven days, and significant ‘ex-ante’ funds will have to be established nationally over the next decade. • Investor compensation schemes, meanwhile, must guarantee to pay out up to €50,000 per investor in the event of investment firm fraud, negligence or administrative error. Brussels is also considering mandating insurance guarantee schemes. However, elements of these proposals are controversial and critics may fight for changes during the legislative process.

16. Basel III: The next round of reform proposals Implications for Derivatives: The European Commission has been consulting very extensively and for many months on legislative proposals covering the over-the-counter (OTC) derivatives market. These are now due to be presented in September 2010. The aim is ensure that standardised OTC derivative contracts are cleared through central counterparties and that there is mandatory reporting of OTC derivatives to trade repositories. Non-centrally cleared contracts will be subject to higher capital requirements, a disincentive which will be introduced through further changes to the Capital Requirements Directive (CRD).

17. Basel III: The next round of reform proposals • Implications for Hedge funds and Private Equity: • Draft legislation has been brewing for months and is now at a fairly advanced stage, but EU member states and the European Parliament are still unable to reach a final agreement on a single set of rules which both support. • The main bone of contention is the terms on which hedge funds or hedge fund managers based outside the EU should be allowed to sell products within the bloc. Diplomats are hopeful that a final deal will be struck in the autumn. The rules would then require all “alternative fund managers” - including those in the hedge fund and private equity sectors - to obtain authorisation before selling products in the EU and meet certain operating and custodial standards.