Europe's Financial Services Regulation Overview
A fundamental objective of the European Union (EU) is establishing and developing the single market in financial services. Whilst the founding Treaty, the Treaty of Rome of 1958, established the four fundamental freedoms of free movement of persons, free provision of services, free movement of goods and freedom of establishment, it was left to the Treaty on European Union, the Maastricht Treaty of 1992, to provide for a further freedom – the freedom of movement of capital and payments. Maastricht laid the foundations for the introduction of the single European currency and the development of a single European capital market (although the bare Treaty provisions could never achieve this alone). The introduction in 1999 of the single European currency, the Euro, within 12 (of the then 15) member states of the EU, served to reinforce the importance of the development of the single market in financial services and made those remaining barriers more prominent.
The single European market in financial services1 would allow financial institutions authorised to provide financial services in one member state to provide the same services in every member state of the EU without the need to comply with different entry requirements, and to be subject to a level playing field within a consistent regulatory environment. Not only would this support the development of the single European capital market and provide competitive access to capital; the potential economic gains are substantial in terms of the productivity of capital and labour, and in turn, GDP growth.
While the Euro focused market participants’ attention on the potential benefits of the single market in financial services, the European Commission’s (Commission) ongoing objective to ensure the consistent and prompt implementation of European law at member state level was thrown into sharp focus. This momentum provided the perfect opportunity to create the legislative structure required to allow the single market to develop its full potential. To that end, the Financial Services Action Plan was drawn up.
In 1998, the Commission was invited to table a “framework for action” to develop the single market in financial services. The resulting Financial Services Action Plan (FSAP) published in 1999 contains a set of 42 original measures (comprising Directives, Regulations, Communications and Recommendations) and a further six supplementary measures, intended to remove the remaining barriers to the single market in financial services and fill certain gaps, so as to provide a comprehensive legal and regulatory environment that would support the integration of European financial markets. An end- 2005 deadline was set for member states’ implementation of the legislative provisions of the FSAP. Practically, this meant that each piece of legislation contained in the FSAP (some threequarters of its measures) would have to be finalised and adopted by around mid-2004 to allow member states the required 18 months in which to draw up national implementing measures.
Each measure of the FSAP falls within one of three strategic objectives as follows:
Recognising that cumbersome legislative measures have done little to improve the efficiency and speed of the European legislative process (by way of example, the proposed Takeover Directive has been negotiated for 15 years to date!), the EU’s Economic and Finance Ministers set a mandate in 2000 for a “Committee of Wise Men” to review the EU regulatory framework and the legislative processes for the securities markets, and produce a report by early 2001.
The final Report of the Committee of Wise Men (chaired by Baron Alexandre Lamfalussy and thus referred to as the “Lamfalussy Report”), published in 2001, proposed new legislative techniques for the reformation of European financial services and securities law. This was the first attempt to address the problems of incoherent, ambiguous and out-of-date legislation that failed to operate effectively at a national level. Indeed, the Lamfalussy Report specifically referred to the FSAP as being designed to fill the lacunae in European financial services and securities regulation. However, it also recognised that the 2005 deadline was highly ambitious – not least because of the lack of basic legislative techniques designed to simplify and speed up the process of adoption of European legislation.
The new legislative techniques proposed in the Lamfalussy Report focused not only on speed, but on quality, flexibility, consistency, transparency and efficiency. The Committee of Wise Men suggested separating the “principle” of legislation from the “detail” in order to minimise ambiguity – thereby allowing detailed technical rules to emerge from the underlying principles.
To that end, the Lamfalussy Report proposed a new four-level approach to the adoption, implementation, evolution and enforcement of legislation within EU member states (hence the term “Lamfalussy process”):
This comprises primary legislative acts, ie, Directives and Regulations that define the broad framework principles, or “essential elements” of each piece of legislation. The Commission, European Council (Council) and European Parliament (Parliament) agree on the key political orientation for each Directive or Regulation (and also the nature and extent of the Level 2 implementing measures), with advice from the European Securities Committee (ESC).
The traditional method of agreeing and adopting legislation at this level utilises the long-used co-decision procedure whereby the Commission, Council and Parliament must all agree on the final text of a piece of legislation. This process takes on average three years to complete and usually involves a number of readings of a proposed text, followed by lengthy consultation periods, and then by numerous rounds of amendments. Even when, for example, a Directive has proceeded through the codecision procedure and takes effect within member states, if it is required to be amended, the proposed amendments are subject to a full-blown consultation under the co-decision procedure – a lengthy and somewhat onerous process.
Under the Lamfalussy process, the co-decision procedure will be restricted to agreeing the key political orientation of a piece of legislation and agreeing on a short-form text, leaving the detail to the Level 2 implementing measures, thus cutting down the time spent on reaching agreement using the co-decision procedure.
Level 2 measures comprise technical implementing measures for the Level 1 legislation that will be adopted by the Commission with the assistance of and advice from the Committee of European Securities Regulators (CESR). The Level 2 measures will contain the detail of the legislation that has been left out at Level 1 and are designed to ensure the speedy adoption of legislation, as well as to avoid the lengthy consultation process involved in amending the Level 1 measures. Ensuring that these Level 2 technical provisions can be quickly and easily amended means that EU legislation keeps pace with market developments. This method, which involves the Commission agreeing upon detailed implementing measures with the assistance of one or both of these Committees, is known as the “comitology” procedure. Comitology forms the core of the Lamfalussy process. It will have an increasing impact on the shape and substance of EU financial services legislation; indeed, use of the process was extended in early 2003 from the securities field to the banking and insurance sectors.
The Level 2 implementing measures for the Directives agreed using the Lamfalussy process take the form of Directives and Regulations, although the Lamfalussy Report urges the use of Regulations rather than Directives. Regulations have the benefit of being directly applicable within member states’ legal systems without the need for member states to draft implementing legislation. Directives leave the form and method of implementation to the member states. Thus there are timing implications where Directives are the chosen form of implementing measure. Although they are said to be the best way to achieve harmonisation of member states’ local laws, the heavy use of Directives pre-Lamfalussy (and indeed, in non- Lamfalussy measures) has led to inconsistent implementation of EU legislation and has also meant that the Commission is unaware of whether correct and consistent implementation is being achieved in each member state.
Level 3 is designed to improve co-operation between national regulators to ensure consistent transposition and interpretation of the Level 1 legislation and Level 2 implementing measures. This involves CESR operating in a different capacity than under its Level 2 responsibilities – CESR will act as a regulatory committee within Level 3, ensuring consistent implementation of the Level 1 and 2 measures. This will be done through the development of CESR “Guidance” covering national implementing measures, the issuing of interpretative recommendations and the setting of common standards where there are gaps in the legislation, together with the comparison and review of regulatory practices to define best practice and ensure consistent application.
Enforcement action by the Commission (or even the threat of it) is recognised as the best way to ensure consistent and timely implementation of legislation within member states. None of the measures progressing under the Lamfalussy process are (at the time of writing) in force, and, although Levels 1 and 2 are in place for many (with Level 3 Guidance being consulted on by CESR), we are not yet in a position to see the operation of Level 4. It is expected that Level 4 will involve the Commission conducting rigorous checks on the texts of national implementing measures and their application and taking action in the form of infringement proceedings against any member state found not to be correctly (or promptly) implementing any piece of legislation.
The Lamfalussy Report recommended the creation of the ESC and CESR, which will act as advisory committees to assist the Commission in implementing the four-level approach. The roles of the two committees are similar yet different – broadly, the ESC operates mainly in an advisory capacity at Level 1 while CESR operates mainly in a regulatory capacity at Levels 2 and 3.
The ESC is composed of high-level representatives of the member states. Its work is twofold, as the Committee acts in both advisory and regulatory capacities. In its advisory capacity, the ESC advises the Commission on the adoption of Directives or Regulations at Level 1 and may be consulted by the Commission before it mandates CESR to provide technical advice on Level 2 implementing measures. In its regulatory capacity, the ESC assists the Commission in exercising the Level 2 implementing measures.
CESR is an independent advisory body composed of representatives of the national supervisory authorities in the securities field of each member state. Its primary role is to assist the Commission in the preparation of Level 2 implementing legislation. The Commission will issue detailed mandates to CESR to prepare implementing measures within defined time limits. CESR will also play a role in ensuring consistent day-to-day implementation of the Level 1 and 2 measures at Level 3, through CESR Guidance.
The end-2005 deadline for implementation of the FSAP means that all member states should have begun consultations on implementing the first major proposals under the FSAP by the end of 2004. In turn, this means that the outstanding measures under the FSAP should have been finalised and adopted by mid- 2004. However, there is still a lot of work to be undertaken in relation to various aspects of the FSAP, including parts of the company law framework, and to the finalisation of the Directives on Transparency Obligations, Consumer Credit and Money Laundering, all of which (at the time of writing) have missed the mid-2004 target for adoption.
It is worth remembering that, while the Level 1 Directives require timely implementation, so do the Level 2 Directives (the Level 2 Regulations will be directly applicable in member states). Even before implementation, the drafting of national legislative provisions involves public and industry consultation, feedback and re-drafting.
The FSA and HM Treasury are already consulting on the implementation of some major aspects of the FSAP within the UK, such as the review of the listing regime required to implement a number of the FSAP proposals and the implementation of Basel II within the EU through the revised Capital Adequacy and Banking Consolidation Directives. Certain parts of the FSA Handbook (the medium through which most of the FSAP Directives will be implemented in the UK) will require substantial amendment, including the Interim Prudential Sourcebooks for Banks, Insurers and Investment Businesses (soon to become the Integrated Prudential Sourcebook), the Conduct of Business Rules, the UKLA Listing Rules and the Market Conduct Sourcebook.
The ambitious 2005 deadline for finalisation of the FSAP leaves EU companies and financial institutions juggling various different regulatory deadlines. Given that many EU companies and institutions will also be struggling to cope with the added burden of compliance with International Accounting Standards / International Financial Reporting Standards from 1 January 2005 and Basel II from 2007, it may be unrealistic to expect full and consistent application of all aspects of the FSAP from 2005. Some interesting issues arise in relation to the Accession Countries that joined the EU on 1 May 2004. Those countries, subject to certain transitional periods, are required to implement the entire FSAP into their national legislative systems within a very short timeframe. Furthermore, local legal, tax and accounting frameworks will all require a degree of harmonisation, even before the provisions of the FSAP can be considered for implementation in Accession countries. The ten countries’ successful integration into the single market will undoubtedly depend on their ability to plan and prepare for the introduction of an entirely new system of financial services regulation.
1 For these purposes, the concept of financial services within Europe is not confined to the field of investment services. It has been accepted over the last 15 years or so as extending to (amongst other things) banking, securities markets, admission to listing, insider dealing and market abuse, clearing and settlement, electronic commerce, accounting standards, pensions and consumer protection.