Euro Crisis Galvanizes Truly Ambitious EU Financial Reforms -- As Early as New Year     Print Email

EU leaders have been galvanized by the Greek crisis into uncharacteristically rapid and remarkable cooperation on critical policy issues, including coordinating fiscal policies and accelerating financial regulatory reform. Already their actions have been remarkable: a 110 billion euro bailout of Greece plus an extraordinary 750 billion euro package combining a new European Stabilization Fund (ESF), EU borrowing and IMF stand-by loans. The package is proof that they understand the critical challenge to the euro and to a single monetary policy posed by international bond markets. Even more importantly, European leaders are proposing coordination of EU fiscal policy in a way euro-skeptics thought impossible before the recent crisis in the eurozone.

As European Commissioner for Internal Market and Services Michel Barnier said in a speech at the European Institute on 11 May: “What happened last Sunday night in the EU is of great importance… Not only did our finance ministers politically agree on an unprecedented series of support measures: political guarantees and loans, with the IMF, up to…750 billion euro. But also they showed, again, determination to act together.”

Now the European Parliament’s Economic and Monetary Affairs Committee has moved to rectify painfully obvious regulatory shortcomings, toughening earlier proposals put forward by the European Commission. The committee set the bar higher with a set of proposals to:


(1) enhance the powers of the proposed European Systemic Risk Board (ESRB) to be effective both before and during a financial crisis;

(2) allow direct EU supervision of systemically important financial institutions; enable temporary bans on risky financial products;

(3) create two EU stability funds.

If the full Parliament and the European Council (heads of EU governments) approve these measures, the new EU supervisory bodies will be based in Frankfurt and supersede the looser network of supervisors in various European cities as originally proposed by the Commission. The final new framework – probably a compromise between the Commission, the Council and Parliament – could be ready by year’s end.

In the Parliamentary Committee plan, the supervisory umbrella authority would consist of three entities, namely the prospective: European Banking Authority (EBA), the European Insurance Authority (EIOPA) and the European Securities and Markets Authority (ESMA).

While based together in Frankfurt, the three regulatory agencies would have considerable independence from each other and employ their own staffs.

The EBA, EIOPA and ESMA would be empowered to draft regulatory financial standards, which would be made legally binding by the Commission (and then legislated into effect in the member states). The agencies would be able to over-ride national decisions that do not conform to EU regulations. They will be part of a process administering "stress tests" on financial institutions. The EBA would also evaluate the accessibility, availability and cost of credit to households and small and medium-sized business. The ESMA, supervising securities firms, would be empowered to ban temporarily certain financial products deemed to pose too much risk. The ESMA would also supervise and regulate credit-rating agencies and clearing houses.

Systemically-important, cross-border financial institutions would be regulated by national supervisors acting as agents of the EU-wide regulators. The EBA would specifically be empowered to regulate cross-border banks operating in the EU. The EBA would also be empowered to handle binding mediation in the event of conflicts between national supervisors.

Financial institutions directly supervised at the EU level would contribute to a European Deposit Guarantee Fund and a European Stability Fund at a rate dependent on each institution’s risk rating. The two funds would be activated when a private financial institution was in trouble and needed refinancing to meet creditors' and depositors' demands – or even to be bailed out. The funds could borrow to increase their resources for major rescue operations. The dual financing of these funds would relieve taxpayers of having to bear the brunt of “Too Big To Fail” financial bailouts.

Overall risk in EU finance and economic stability would be monitored by a new, independent European Systemic Risk Board (ESRB), to be chaired by the European Central Bank president. The ESRB would develop indicators to permit uniform ratings of the riskiness of specific cross-border financial institutions. It would have to notify the European Parliament and the three regulatory authorities of any imminent emergency.

The European Parliamentary Committee also proposed circumscribing EU member governments’ right to invoke the "safeguard clause" as a way of avoid implementing ESRB or other EU regulators’ decisions. This provision has enabled governments to avoid implementing painful rulings on the grounds that doing so would cause budgetary problems. This politically sensitive idea was supplemented by the Commission’s proposal on 12 May that eurozone governments vet each other’s budget plans before national legislative approval – a concept sure to raise hackles about national sovereignty but one that is cropping up in different forms as a way to promote fiscal discipline across the EU.

These enhanced regulatory reforms are expected to be voted on at the Parliament's June plenary session. If also approved by the EU Council, a big if, the ESRB and three regulatory authorities would be created in 2011, sooner than anticipated for the Commission’s more diffuse original proposals.

If EU leaders dither and fail to agree on regulatory and fiscal reforms, there will be more trouble.

As Commissioner Barnier warned: “Our negotiations can lead to complicated compromises. And too many compromises can lead to the lowest common denominator being adopted. More worrying, financial markets move fast. Much faster than our political processes. There is the risk of simply being too late.”

J. Paul Horne is an independent international market economist, who was a managing director and international economist at Smith Barney/Citigroup. He is based in Europe and the U.S. See Horne’s recent piece on EU regulatory reform in the latest edition of European Affairs.