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«Summer 2014 Review of the Balance of Competences between the United Kingdom and the European Union The Single Market: Financial Services and the Free ...»

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These can take the form of Regulations, Directives, or Decisions: Regulations are directly applicable and binding throughout the EU without further enactment; Directives lay down the end results that must be achieved, but leaves to national authorities the choice of form and methods for achieving this within their domestic legal order; Decisions relate to specific cases (unlike Regulations) and are binding on those to whom they are addressed.

The ECJ interprets the Treaties and the legal acts which the EU adopts and, in the event of a reference to the ECJ, decides if an institution or body of the EU or a Member State has abided by them.

2.4 The EU may act only where the EU Treaties so provide. The provisions of the TFEU that provide the main possible bases for action by the EU in the area of financial services and the Free Movement of Capital are Articles 53, 63, 64, 65, 113, 114, 115, 127(6) and 352.

These are described in more detail in Annex E.

The Council of Ministers is organised according to the particular policy area. In the area of financial services the Council is called ECOFIN; but any Council formation is constitutionally permitted to take decisions on behalf of the Council, and financial services legislation can be formally agreed at a Council meeting of ministers responsible for quite different policy areas. The European Council refers to heads of government.

The European Parliament has established a number of specialist committees to cover particular policy areas.

The Economic and Monetary Affairs Committee of the European Parliament (ECON) agrees draft reports on legislative proposals which are then adopted by the Parliament in Plenary session. The chair of ECON exercises considerable influence on the legislative process, as do the rapporteurs and shadow rapporteurs who are responsible for drafting the reports.

22 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 Institutional and Policy-Making Framework

2.5 The Commission has the sole right to propose new or revised EU financial services legislation (the ‘right of initiative’). The Commission is required to consult publicly before making formal proposals and to undertake impact assessments to understand the potential consequences of its proposals. These are designed to gather evidence on the advantages and disadvantages of possible policy options by assessing their potential impact. The resulting impact assessments, which are published online, should also explain why action is necessary at the EU level and why the proposed response is appropriate and proportionate. The process is also intended to help bring transparency and accountability to the preparation of legislation.

2.6 Once the Commission’s proposal is published, it is considered simultaneously by the two co-legislators – the Council and the Parliament. There are two over-arching legislative procedures: ‘ordinary’ and ‘special’. Most of the legislative powers relevant to financial services allow EU measures to be adopted using the ordinary procedure formerly referred to as the ‘codecision procedure’ and described in Articles 289(1) and 294 TFEU.

2.7 The ordinary procedure involves a vote on the measure by the Council acting by qualified majority, with the larger Member States having more votes than smaller ones,3 and the Parliament acting as co-legislator and by a simple majority of its members, with larger Member States having more Members of the European Parliament (MEPs) than smaller ones.4 This procedure puts the Parliament on an equal footing with the Council. Other legislative powers require agreement using a special procedure, under which the Council may in practice be the sole legislator following a proposal from the Commission, though the Council must consult or seek the consent of the Parliament in specified cases.

2.8 Under the ordinary legislative procedure, both the Council and the Parliament may amend the Commission’s proposal and add substantive provisions which have not been subject to consultation or an impact assessment. To reach joint first reading agreement on a final text, under an informal process known as a ‘trilogue’, compromise is sought through negotiations between representatives of the Council and Parliament, with participation from the Commission.5

2.9 Frequently, Regulations and Directives will contain legislative delegations, permitting the Commission to adopt subordinate legislation. In the area of financial services, the

subordinate Level 2 legislation takes one of two routes:

• The delegation may be direct to the Commission, in which case the Commission does not generally consult or undertake an impact assessment and the Council may prevent these rules being adopted only if there is a qualified blocking majority of votes against the proposal;6 Where legislation is adopted by Qualified Majority Voting, the total votes of Member States favouring the measure must be 260 or greater out of 352. The UK, Germany, France and Italy each have 29 votes. After the transitional period has ended on 31 March 2017, a qualified majority will always require 55 per cent of Member States, comprising at least 15 of them, and representing 65 per cent of the EU population.





As of the 2014 elections, there are 751 MEPs. The UK and Italy have 73 MEPs, France 74 and Germany 96.

While First Reading agreements via trilogues have become the normal approach to agreeing legislation, the TFEU provides for more extended consideration at a Second Reading, in circumstances where the Council and Parliament do not agree on the amendments each has made to the Commission proposal. If a Second Reading agreement is not reached, the Conciliation Committee is convened and has six weeks to find an agreement, which must then be approved as a package at Third Reading, failing which the proposal is not adopted.

The Commission may, however, be required to do so, for example, as a result of the application of a Comitology Procedure in relation to a specific Commission implementing act.

Chapter 2: Current State of Competence 23

• The second route requires the relevant European Supervisory Authority (ESA) to draft rules, known as Binding Technical Standards (BTSs), for the Commission to adopt with or without amendment. In recent years, the ESAs have had to draft a large number of BTSs, some to very short deadlines. Although the ESAs are required to consult and undertake cost-benefit analysis on them, the volume of BTSs and the short deadlines contained in the empowering legislation may affect the quality of final rules.

Key Pieces of EU Legislation

2.10 In a modern economy, financial services perform a number of key functions, including:

• Allowing firms and individuals to make payments;

• Providing financial intermediation between savers and borrowers to allow individuals to smooth consumption over their lifetime, and between investors and businesses to help allocate capital efficiently within the economy;

• Creating markets for debt, equity, foreign exchange and commodity exposures to be bought and sold; and

• Providing insurance against future risks.

2.11 There are different risks surrounding the provision of these services, which countries have sought to mitigate through a wide range of rules. The creation of a single market in financial services in the EU requires Member States to remove obstacles to the purchase and sale of financial services. Many of these obstacles are national rules that have been developed to maintain financial stability, protect consumers and ensure markets operate fairly and cleanly. Removing these barriers to trade necessarily requires there to be effective EU-level rules instead. It is important that these rules address the risks that each sector presents in a proportionate and effective way. The following section sets out the key risks of each sector and the main pieces of legislation that have been designed to address these.

Banking

2.12 The business of banking centres on borrowing and lending money. Banks have relatively little money (shareholders funds) of their own. Most of the money they lend is borrowed, and much of that is repayable on demand (deposits) or raised for a fixed period of time (for example, five year bonds). However, much of what banks lend will not need to be repaid

for two or more decades. The nature of banking, therefore, includes the risks that:

• Banks cannot repay borrowers on demand or pay back bondholders whose bonds have matured, because that money has been lent and is not due to be repaid for ten or twenty years;

• Banks that make large losses on their loans or trading activities will not have enough of their own money, and therefore those lending to banks (depositors and bondholders) may be exposed to the risk of loss;

• Lending practices that are rational for an individual bank will have a different impact if copied by the whole industry. For example, reducing lending in the expectation of a down-turn in the economy would tip an economy into recession if all banks behaved in the same way; and

• Troubled banks which are not in a position to raise additional funds from shareholders, will cut back the size of their loan book and this will disproportionately affect new customers, small businesses and others dependent on overdrafts and other forms of 24 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 short term borrowing. If a number of banks are stressed at the same time, the flow of credit will be reduced and the economy will contract.

Overview of the UK’s Financial Sector Banking Retail and commercial banks, cooperatives, building societies and other mutual organisations (such as credit unions) offer a range of banking and related services to consumers and businesses. Related services include credit cards, business loans and mortgage lending. Investment banking includes equity underwriting, fixed income underwriting, mergers and acquisitions, and syndicated loan business.

Investment Firms and Markets Investment firms (which include investment banks) trade equities, bonds and derivatives on the secondary markets. They act as brokers, market makers or deal on their own account.

Brokers bring together potential buyers and sellers in financial markets across many different asset categories. Market infrastructure includes the exchanges and other trading venues (for example, the London Stock Exchange and the London Metal Exchange), clearing houses (for example, LCH Clearnet) and settlement systems (for example, CREST).

Asset Management Fund managers manage funds on behalf of institutional clients (such as insurance funds and pension funds), retail clients and private clients. The industry also includes property funds, hedge funds and private equity funds.

Insurance and Pensions The insurance industry provides long-term insurance (such as life insurance, endowment policies and annuities) and general insurance (such as motor or property insurance). In addition, the Lloyd’s market, based in the City of London, is regarded as the centre of the world’s insurance and reinsurance industry. The contracts traded on the Lloyd’s market often involve higher exposure risks. Pension funds, which are attached to sponsoring companies, invest over the long term to provide employees with pensions when they retire.

Independent Financial Advisers Independent Financial Advisers give consumers unbiased and unrestricted advice on a range of financial matters, including retirement plans, life policies and investments. Their advice needs to be based on a comprehensive analysis of the relevant market.

Professional and Support Services The size of the UK’s financial sector has created strong demand for complementary services, such as legal services, accountancy services, and consultancy and advisory firms.

2.13 Banks may make losses for a number of reasons, including because: their business plan exposes them to risks they fail to understand; their credit assessment of clients is faulty;

they are over-exposed to particular sectors of the economy, for example, commercial property; their funding models expose them to foreign exchange risk, for example, if they raise money in one currency and lend in another; of interest rate risk, for example, if they raise money on floating interest rates, but lend at fixed rates; or of operational risk, for example, if they missell products and subsequently have to provide redress.

Chapter 2: Current State of Competence 25

2.14 Regulation has therefore focused on ensuring banks mitigate these sources of risk

by setting:

• Minimum levels of capital so that banks can absorb losses and reduce the risk of failing;

• Minimum funding arrangements, so that banks remain liquid and can repay depositors and other creditors;

• Flexible additional levels of shareholder funds to support them during more challenging parts of the economic cycle; and

• A range of other requirements, for instance relating to business plans, risk management systems, remuneration policies, IT systems and governance.

2.15 Within the EU, regulatory rules were amended to bring them into line with the revised international standards agreed by the Basel Committee on Banking Supervision (BCBS) in the wake of the financial crisis. The Capital Requirements Directive (CRD) IV and Capital Requirements Regulation (CRR) put into rules these updated standards and cover the authorisation of banks and subsequent prudential supervision of banks and investment firms, including through rules on capital, liquidity and credit risk. Many standards in CRD IV are, however, specific to the EU. Chapters Three and Four set out a number of criticisms in evidence regarding the implementation in the EU of these international standards.



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