«Summer 2014 Review of the Balance of Competences between the United Kingdom and the European Union The Single Market: Financial Services and the Free ...»
1.12 The global financial and euro area crises that struck from 2007 changed the focus of EU rule-making from market opening to the safety and soundness of the whole financial system, as well as individual firms, and increased the attention paid to the protection of consumers and tax-payers. The Financial Stability Board (FSB), under the political direction of the G20 at the Pittsburgh summit in September 2009, took the lead in coordinating the agenda with the other Standard Setting Bodies (SSBs) to reform the regulatory regime, make the financial system safer, and deal with the problem of banks that are too big to fail or, in the case of some countries, to save.8 Within the EU, heads of Government also agreed in 2009 that the EU should henceforth have a single rulebook for financial services.
The Commission then used the implementation of the revised international standards to create the single rulebook by using, to a greater extent than before, Regulations rather than Directives9 and by making more provisions maximum harmonising.10 The implications of these shifts are considered in Chapters Three, Four and Five.
The EU had, from its early days, adopted procedures to give the Commission limited rule-making powers, where a Directive or Regulation so provides. These rules were agreed in so-called Comitology Committees, and were designed to be quicker and easier to agree and amend than a full legislative process. The Lamfalussy changes envisaged that the detail which had previously been agreed through line by line negotiation would in future be dealt with by the Commission, and only the high level issues, objectives, scope, powers etc would go through the full legislative procedure. The Treaty of Lisbon put subordinate legislation on an explicit Treaty basis in articles 290 and 291 of the Treaty on the Functioning of the European Union (TFEU).
The financial and euro area crises have shown that countries may find it difficult to save banks whose balance sheets represent large multiples of that country’s GDP.
Directives lay down the end results that must be achieved, but leave to national authorities the choice of form and method for achieving this within their domestic legal order, and so provide a degree of flexibility to national authorities. Regulations are directly applicable in Member States and provide greater consistency across the EU, although specific characteristics of national markets may not be recognised.
EU rules may permit Member States to impose additional requirements to the EU ones, thereby setting a
1.13 The large volume of legislation that resulted was mostly negotiated and adopted under the Lisbon Treaty,11 which gave to the European Parliament powers equal to those of the Council of Ministers in all Single Market areas and also gave a clear EU Treaty basis to subordinate legislation adopted by the Commission (‘Level 2’ out of the four levels set out in the Lamfalussy report).12
1.14 The financial crisis also exposed the shortcomings in the EU’s system of financial supervision and thereby triggered institutional changes.13 In 2008, the Commission mandated a high-level group chaired by Jacques de Larosière to make recommendations on how to strengthen supervisory arrangements across the EU, of which the chief recommendation was to establish a European System of Financial Supervision comprising EU supervisory bodies for the banking sector, markets and securities, insurance and occupational pensions, and macro-prudential oversight. As a result, the EU reconstituted the committees of national supervisors established, following the Lamfalussy Report into EU agencies the European Supervisory Authorities (ESAs) – with powers to take decisions binding on national supervisors and, in limited circumstances, on firms.14
1.15 By 2010 it had become clear that the balance sheets of a significant proportion of the banking industry in the euro area were impaired. Funding both for sovereigns in peripheral euro area states and their banks dried up. It was recognised that extensive recapitalisation would be needed, but it was less clear where the capital would come from. The euro area crisis drove a realisation that a single currency requires greater political, economic and institutional integration than was initially envisaged, mainly because of the intimate interconnection between currency stability and the stability of banks within a currency union through their ability to amplify and transmit risk to other euro area countries. The logic of a single currency led to the Commission’s proposals for the establishment of a banking union for the euro area, involving three key elements: a single banking supervisor;
a single resolution authority and resolution fund; and a common system for deposit protection.15 The Lisbon Treaty entered into force 1 December 2009.
For more information on the Lamfalussy Report, see: ec.europa.eu/internal_market/securities/lamfalussy/ report/index_en.htm, accessed on 13 June 2014. The Lamfalussy Committee envisaged a four level structure to EU regulation. Level 1 would be principles based framework legislation decided by co-decision (under Lisbon the ordinary legislative procedure); Level 2 would be the detailed implementing decision decided under comitology (under Lisbon delegated and implementing acts); Level 3 would be advice to the Commission by national regulators in the Level 3 Committees (now the ESAs) who would also promote supervisory convergence; and Level 4 would be enhanced focus by the Commission on enforcement (now helped by the ESA role of investigating potential breaches of Union law). The Lamfalussy report focused on securities markets but was subsequently applied to banking and insurance and occupational pensions.
For instance, the collapse of Iceland’s banks – and the resulting losses on deposits in Germany, the Netherlands and the UK – highlighted that EU rules are not always enforced by national supervisors, and that this non-compliance was largely invisible and difficult to mitigate until it was too late.
The three ESAs are the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA), and the European Securities and Markets Authority (ESMA). The European Systemic Risk Board (ESRB) has also been established and is responsible for performing certain tasks relating to macroprudential oversight.
Participation in banking union is mandatory for euro area Member States and optional for non-euro area Member States. The European Central Bank will become the prudential supervisor of credit institutions established in those states.
18 Review of the Balance of Competences between the United Kingdom and the European Union:
The Single Market: Financial Services and the Free Movement of Capital
1.16 Steps have already been taken to establish a Single Supervisory Mechanism (SSM) for participating Member States with the European Central Bank (ECB) directly supervising the largest 128 banks in the euro area, and with powers of direction over the others. A Single Resolution Mechanism (SRM) has also been agreed so that failing banks in the banking union can be restructured, sold off or wound down in an orderly way with minimal cost to tax-payers or the wider economy. The Regulation establishing the SRM is accompanied by an inter-governmental agreement which includes arrangements for Contracting Parties to transfer contributions collected from the financial industry, for the purposes of resolution financing, from the national level to a Single Resoution Fund.16
1.17 The UK Government has been clear that it will not participate in the banking union, and non-participating Member States, including the UK, have secured clear provisions that, taken together, help protect the Single Market by ensuring non-discrimination and providing equal treatment between participating and non-participating Member States.17
1.18 Many operational aspects of the banking union have yet to be determined, but it is evident that this deepening integration will have a profound effect on the Single Market and the UK’s relationship with the EU in financial services as well as in other fields.
The Free Movement of Capital
1.19 The Free Movement of Capital refers to all movements of capital from payments, portfolio investments and direct investment in a country, to loans for the purchase of tangible property, bank-notes and financial guarantees.
1.20 Prior to 1993, Member States were required to abolish restrictions on the Free Movement of Capital, but only to the extent necessary to ensure the functioning of the then common market. As a consequence, the Free Movement of Capital was widely perceived as a necessary but somewhat supporting right, compared to the other Treaty freedoms.
However, the Maastricht Treaty, which came into force in 1993, brought the Free Movement of Capital from the margins to centre stage by prohibiting all restrictions on the movement of capital and on payments.18 Contracting Parties are Member States participating in the banking union and other Member States who chose to be Contracting Parties.
Protections in the SSM Regulation that the UK and other non-participating Member States have secured include: a prohibition on discrimination by the ECB; a requirement by the ECB to enter into a memorandum of understanding with supervisory authorities of non-participating Member States; voting safeguards in the EBA to address the risk that banking union members vote as a bloc; a requirement for EBA members to strive for consensus; and a requirement that the EBA’s powers apply to the ECB as banking union supervisor in the same way as they do to a national supervisor. Protections relating to the SRM Regulation include: the equivalent application of State aid rules to any use of the Single Resolution Fund as compared to national resolution financing arrangements in non-participating Member States; an explicit requirement that the Commission and Single Resolution Board (SRB) cannot discriminate against entities in non-participating Member States; the EBA will have the same remit over the Council, the Commission, and the SRB when they are performing their tasks under the SRM as it has over national resolution authorities in non-participating Member States; and the Commission must establish ‘Chinese Walls’ between its resolution tasks under the SRM and its other functions to ensure it is fully aligned with the rules which apply to national authorities involved in resolution decision-making under the Bank Recovery and Resolution Directive and international standards developed by the G20 and FSB.
Specifically Article 63 of the Treaty on the Functioning of the European Union (TFEU). See paragraphs 2.2 and
2.4 below for a description of the EU Treaties.
Chapter 1: Development of EU Competence 19
1.21 The last thirty years have seen the progressive relaxation of capital controls around the world. The Organisation for Economic Co-operation and Development’s (OECD) Code of Liberalisation of Capital Movements requires the progressive, non-discriminatory liberalisation of capital movements among member countries. As part of this trend, the UK abolished exchange controls in 1979, 15 years before the Treaty of Maastricht prohibited inward and outward restrictions on the Free Movement of Capital.
1.22 The domestic impact on the UK of this Treaty freedom has, therefore, been limited. The UK’s policy of open markets means there were already very few restrictions on ownership of land, direct or portfolio investment, or the ownership of companies. As a result, from a UK perspective the dismantling of restrictions on the Free Movement of Capital is a story of the deepening of the Single Market and the opening up of national markets in other Member States to competition.
1.23 The Free Movement of Capital is central to the functioning of financial intermediaries, such as banks, securities firms and fund managers, but it is also a precondition for foreign direct investment both by UK firms in the EU and by EU firms in the UK. UK firms have invested most heavily in the EU’s information and communications sector, while the UK sectors that have received the most direct investment from the rest of the EU are those in retail and wholesale trade.
1.24 The TFEU does, however, allow limited exceptions to the Free Movement of Capital, including in relation to: macroprudential regulation and capital controls; tax differentiation;
public policy; public security; national security and defence; and financial sanctions. The scope of some of these exceptions, however, has been subject to critical examination in a series of cases brought before the ECJ. Regarding capital controls, in March 2013 Cyprus became the first, and so far the only, Member State with previously liberalised capital flows to implement strict controls on the transfer of capital outside of the country. These capital controls were to prevent bank depositor flight, following the bail-in of bondholders and depositors in the two largest Cypriot banks.
Chapter 2: Current State of Competence
2.1 This chapter summarises current EU competences in financial services and the Free Movement of Capital, and is necessarily a high-level account of a complex area. It details the main legal provisions in the EU Treaties which define those competences, and identifies the key pieces of EU legislation which affect the provision of financial services and the movement of capital – further details on each of these are included in Annexes E and F. The institutional and policy-making frameworks which underpin and facilitate the exercise of the EU’s competences in these areas are also outlined.
The Treaty Framework
2.2 The two core functional treaties which determine how the EU works and operates are the Treaty on the European Union (TEU), originally adopted as part of the Maastricht Treaty, and the Treaty on the Functioning of the European Union (TFEU), derived from the original Treaty of Rome.
2.3 The TFEU empowers the EU institutions, notably the European Council, the Council of Ministers (‘the Council’),1 the Commission and the Parliament,2 to adopt legal acts.