New dawn for financial regulation

Date: 14/03/02

AFTER a delay of almost one year, on 5 February the European Parliament approved the new Alexandre Lamfalussy approach for EU financial services legislation.

The Parliament agreed to have a lesser say on secondary legislation, which should in future allow for swifter changes to securities market legislation, in return for a promise to review the situation in 2004.

In the meantime, the European Commission organised a mid-term review of the financial services action plan on 22 February, to provide a new impetus to the outstanding pieces of legislation.

This is therefore a good time to evaluate what has been achieved in the area of financial services legislation, and what remains to be done.

The agreement with the European Parliament can certainly be regarded as a success. The long-awaited EU Securities Committee will finally come into being. A high-level Securities Committee had been expected since the agreement on the Investment Services Directive (ISD) in 1992, but the delay has borne fruit. The new committee will have more powers than the equivalent committees in banking and insurance.

The one-year delay in the adoption of the Lamfalussy approach is not disastrous. The Commission has already issued two draft directives following the new approach - the draft market abuse and prospectus directives. The first Parliament readings on these drafts have in the meantime been passed.

The Securities Committee could in some way be considered as an embryonic Securities and Exchange Commission (SEC). It will have broad decision-making powers, and will decide by qualified majority. Decisions in the committee could thus go against the interests of certain member states. The structure of the European SEC will, however, remain decentralised for some time to come.

The committee will be chaired by the relevant commissioner, but its decisions will be largely prepared by the Committee of European Securities Regulators (CESR), which will work independently from the EU executive. CESR will have its own secretariat in Paris, and be chaired by a member state representative. CESR and the Commission will thus cooperate and compete at the same time, which should be good for the quality of regulation and its enforcement.

The intense activity at the level of securities market regulation over the past month reflects this strong interaction between the Commission and the member states.

The broad thrust of the new proposals and communications, which have been launched since the Lamfalussy report, can be welcomed. They have increased the awareness in the EU and beyond of the issues at stake. The draft directives and communications are based on the principles of strengthening disclosure and enforcement in securities market regulation.

The draft prospectus directive requires member states to de-couple listing from trading, which should ease cooperation between the supervisory authorities and stimulate market integration.

The Lamfalussy report stated that, if its own proposals were rejected, a single European Financial Services Authority (FSA) should be considered. However the adoption of the Lamfalussy approach will make the argument for an EU FSA superfluous.

Functional cooperation among member states, rather than an FSA, will most likely be more appropriate in a European context. An EU FSA would not be adequate for a host of reasons, most importantly from a financial regulatory perspective. It would also be difficult to reconcile with the basic single market principles of subsidiarity, minimal harmonisation and home country control.

The Lamfalussy approach does however raise a series of questions. Several of these had already been discussed when the Lamfalussy report was first published. Others have been raised since.

The Lamfalussy report proposed to work with framework directives, and to leave the detail to be decided by the Securities Committee. However, even the first draft directives following this new approach were very detailed.

This will be even more the norm once the European Parliament's amendments have been incorporated. As the European Parliament will have no direct say in decisions by the Securities Committee, it has proposed an enormous number of amendments - 240 in the case of the draft market abuse directive.

Moreover, the Parliament may have a different view on what is framework and what is detail than the European Commission, as there is certainly no basic theory on this.

Framework directives under the Lamfalussy approach could thus be considered a contradiction in terms. They were designed to lighten regulation, but may end up increasing the burden.

What degree of harmonisation? It is clear that the EU regulatory frame-work for securities markets did not work sufficiently well because the degree of harmonisation was insufficient.

The Commission, however, has to remain vigilant and not go for too high a level of harmonisation. This is clear from the communication on the revision of the Investment Services Directive (ISD).

Too much harmonisation may stifle market innovation and reduce regulatory competition. It could also weaken market mechanisms and self-regulation, which are important components of healthy securities markets.

How to open-up securities settlement markets? Settlement systems have recently come to the fore, and discussion continues on what is the most appropriate structure for Europe.

Some have argued for a European monopoly, others have called on the European Commission to be more vigilant on anti-competitive practices.

The result of the increased attention may be that the securities settlement systems (SSS) will become even more regulated. Since a variety of regimes for SSS exist in Europe, the Commission may have to rely on more complex regulations to open up markets, covering licensing, access, transparency and governance.

This will most likely delay market liberalisation and runs the risk of rendering the process very bureaucratic.

The reactions to the first proposals, certainly to the draft prospectus directive, have been fairly unbalanced in the sense that the criticism was mainly voiced by representatives of issuers, not investors.

It is obvious that issuers do not like a heavier regulatory regime, since it increases the cost of issuing.

Investors, on the other hand, should welcome more disclosure, but the problem is that they are poorly represented at European level.

This applies as well for institutional and individual investors, and is ultimately a reflection of the European financial system, which is still for the most part intermediated by banks.

Whether the Lamfalussy approach will be followed in other areas of financial regulation remains to be seen.

The Commission may be reluctant to extend the approach to other areas, when one considers the problems of establishing it for securities markets in the first place. Moreover, Parliament will be suspicious of having created a precedent.

Nevertheless, the implementation of Basel II, new rules governing the capital banks need to set aside for loans, is an obvious candidate.

Major feature examining what has been achieved in EU financial services legislation, and what remains to be done following approval of the 'Lamfalussy approach' by the European Parliament, 5 February 2002.