On 12 March 2021, the European Commission (“EC”) launched a targeted consultation on supervisory convergence and the single rulebook for the three European Supervisory Authorities (“ESAs”): the European Banking Authority (“EBA”), the European Securities and Markets Authority (“ESMA”) and the European Insurance and Occupational Pensions Authority (“EIOPA”).
The single rulebook aims to provide a unified regulatory framework for institutions across the EU. European legislation has previously been dominated by Directives which by nature require Member States to achieve a particular result without prescribing the means to achieve said result. This has historically created a degree of flexibility since Directives can be adopted using a variety of measures which cater for national differences in legal systems across EU Member States.
This leeway has, however, accommodated divergences in national rules and the application thereof. In some cases this can lead to regulatory arbitrage which compromises effective competition and undermines investor confidence in the single financial market. The single rulebook therefore seeks to promote harmonization of rules across EU Member States with the intention of promoting and protecting the single market.
The Capital Markets Union (“CMU”) Action Plan published on 24 September 2020 requires the EC to both review the current framework for supervising European capital markets as well as take further steps towards achieving the single rulebook by Q4 2021. Participants were invited to provide feedback by 21 May 2021 via an online questionnaire. ESMA published its response to the targeted consultation on 26 May 2021.
The consultation is organized into two sections which aim to take stock of the existing mandate of the ESAs. The first section includes a detailed assessment of the ESAs’ supervisory convergence and direct supervisory powers, governance and the role of the ESAs regarding systemic risk, while the second section relates to general actions taken towards achieving the single rulebook.
The consultation will be used to inform any future changes to the ESAs’ Regulations as regards the expansion of their direct supervisory powers as well as any decisions to adjust processes and timelines for developing and publishing technical standards and guidelines produced by the ESAs.
With reference to the regulation Levels, the consultation explores whether the granularity of EU legislation Levels needs to be revised to reduce divergences across Member States. Respondents are invited to suggest improvements regarding the application dates and sequencing of Levels 1, 2 and 3. One question asks for comment on which sectors have experienced detrimental gold-plating.
ESMA notes that the COVID-19 crisis has highlighted the need for flexibility in the regulatory framework. As it currently stands, amendments which address market changes require a Level 1 legislative process which can take years to finalize, meaning that unanticipated yet necessary legislative changes cannot be made swiftly. Given this, ESMA proposes that further consideration be given to the possibility of assigning technical rulemaking to ESMA via Level 2 mandates.
The EC questions if the technical standards and guidelines produced by the ESAs are effective in harmonizing the application of rules. The process and deadlines to develop and amend these standards and guidelines are also reviewed.
In response, ESMA suggests that the EC reduces the number of options provided in Directives and that potential divergences in implementation be clearly addressed upfront. It is suggested that this could be achieved through a review of certain sectoral legislation, such as the upcoming reviews of the Markets in Financial Instruments Directive (MiFID) and UCITS Directive.
In this section the EC assesses the effectiveness of the ESAs’ existing supervisory toolkit and whether it needs to be expanded. There is a specific focus on common supervisory action (CSA), the new processes for Q&As, No Action Letters and Peer Reviews, as well as the new Union strategic supervisory priorities and coordination functions. The powers of the ESAs in relation to the application, mediation and settlement of breaches of Union law is another point under discussion.
The ESAs were reviewed in late 2019 and amended in January 2020. In ESMA’s view it is too soon for any recent changes to be meaningfully evaluated, generally speaking. Despite this, ESMA has noted that the fast-track Peer Review process has already had a positive impact. Similarly, ESMA has launched CSAs in the recent past which have made inroads in converging the application and implementation of rules across the EU, examples of which include the CSA on the supervision of costs and fees of Undertakings for the Collective Investment in Transferable Securities (UCITS) and the CSA on the supervision of UCITS’ managers liquidity risk management across the EU.
On the contrary, the new Q&A process is proving to be slow and inefficient, which is problematic given that its success lies in the ability to provide timely information. While No Action Letters were also recently introduced, ESMA found limitations in their usage and as such defaulted to non-prioritization supervisory statements instead, arguing that a tool which would allow ESMA to react more quickly to market and international developments would be beneficial.
Direct supervisory powers
In this section the EC aims to gather feedback on ESMA’s direct supervisory powers regarding Credit Rating Agencies, Trade Repositories and Securitization Repositories. Respondents are invited to share their suggestions on the principles that should govern the decision to grant direct supervision.
ESMA’s supervisory responsibilities have expanded in recent years to cover data service providers, critical benchmarks, securitization repositories and securities financing transactions, yet many of these powers have only recently or partially taken effect. ESMA highlights that industries with a strong element of cross-border delegation across the EU could benefit from direct supervision as they may present a risk of regulatory arbitrage resulting from differences in application of rules across Member States. Similarly, they believe that the topic of EU level supervision could be elevated, particularly in instances where non-EU entities are able to service the European market, where ESMA could act as a gatekeeper to the capital market. ESMA also believes that the best outcomes will be achieved if supervision and enforcement work hand in hand.
The consultation requests an assessment of the quality of market development analysis, stress tests and transparency exercises initiated and coordinated by the ESAs as well as a review of the development of a common set of quantitative and qualitative indicators to identify and measure risk.
The constantly transforming financial market and adoption of new underlying technologies has created the possibility of new risks emerging within the financial system. ESMA believes that regulators and supervisors need to improve their data capabilities to prevent, detect and mitigate these risks. To this end, ESMA intends to become a data hub for EU securities markets (ESMA’s Strategic Orientation 2020-22), which if achieved will significantly reduce the duplication of effort, as well as the time and cost burden associated with data collection and reporting for national competent authorities (NCAs). That being said, ESMA recognizes that building this data hub will require substantial financial and human resources.
The consultation asks whether the ESAs’ governance framework ensures objectivity, independence and efficiency in their decision-making. Questions look at gathering input on the role, allocation of tasks and decision-making abilities of the Chairperson, the Board of Supervisors and Management Board. The EC also collects views on the involvement of various stakeholders in the ESAs’ decision-making processes and whether these stakeholder groups provide a balanced representation of views. The effectiveness of Joint Committees is also evaluated.
Although the ESAs’ Founding Regulations were reviewed in 2019 and amended in January 2020, new risks introduced to the financial system due to COVID-19 and the departure of the UK from the EU have dramatically altered the landscape. A reflection on the ESAs’ progress is therefore still warranted despite the limited time for changes to be embedded and experienced.
Expanding the existing toolkit: A major focal point of the consultation is the extent to which the ESAs’ existing toolkit caters to the demands of the financial market and if so, whether this toolkit is fully utilized. Where CSAs and the new process for Peer Reviews have been positively received, ESMA notes that the new processes for Q&As and No Action Letters have not been fit for purpose so some amendments may be anticipated in this area. Yet, only 18 months have lapsed since the ESAs’ Regulations were updated and as such any assessments of, or changes to, the toolkit may be premature.
Increasing direct supervisory powers: Currently, most asset managers are regulated at an EU level by the UCITS or Alternative Investment Fund Manager (AIFM) Directives. In addition, fund distribution across the EU differs depending on the attitude towards saving and investing of each Member State. NCAs are well-established and experienced in supervising asset managers in their jurisdictions, which is in part influenced by their knowledge of and proximity to the local markets and their ability to understand the needs of market players. Further, a management company’s daily operations are often governed by local rules and laws, such as, inter alia, company law, contract law and tax law. Consequently, NCAs are often best-placed to accurately and effectively supervise asset managers in the local environment. With this in mind, should further direct supervision be implemented, this may infringe on a management company’s ability to deliver daily operations and fund offerings. Granting direct supervisory power to the ESAs in instances such as these may risk the ESAs and NCAs being drawn into legal clashes.
Applying flexibility for the timelines to develop technical standards and guidelines: The ESAs are often not given sufficient time to consult on technical matters, resulting in Level 2 and 3 outputs that are rushed. Increasing the timelines and adjusting the granularity and sequencing of Level 1, 2 and 3 regulatory changes would allow the ESAs to provide more relevant and appropriately detailed responses to asset managers across the industry.
The targeted consultation and potential outcomes thereof may present opportunities for the EC to enhance the existing supervisory powers of the ESAs. While any proposed changes may not be applicable in the immediate future, the considerations outlined above will be essential in bringing about convergence towards the single rulebook across the EU Member States.