Clearing and Settlement: Is Regulation Needed?
The green paper on ‘Financial Services Policy 2005-2010’ sets out the principles that will chart the EU Commission’s financial services course over the next five years. There is no grand revelation in its first two objectives. They simply affirm a familiar theme: to make progress towards an effective European financial market and to foster a market where financial services and capital can circulate freely, supported by appropriate levels of risk management.
It is the third aim that suggests the next five years will be substantially different from the last 10, for two reasons. First, the Commission intends to continuously evaluate the existing legislative framework before recommending new legislation. And second, it pledges to rigorously deploy the ‘Better Regulation’ agenda for any future proposals.
At the European level, we can expect new legislative proposals to be backed with firm evidence that such legislation will improve the competitiveness of Europe’s financial markets, facilitate cross-border business, safeguard stability and promote growth. If the proposals do not meet these standards, Internal Market Commissioner McCreevy has made it clear that they will not go forward to the European Parliament and the Council of Ministers.
Existing laws are also to be put to stern tests in terms of their effectiveness. In so doing, the Commission intends to confirm that existing directives and regulations are delivering the expected economic benefits, and annulling those that are not up to the grade. Even without new legislation, it looks as though Commission staff will find themselves fully occupied in the coming years.
The Commission will also examine the practice of gold-plating legislation, which sounds good, but in fact leads to a particularly complicating condition known as regulatory creep. This happens when member states use the opportunity when adopting European laws onto their own national rule book to improve on the original concept by adding further measures, covering more situations. The temptation may be very understandable, but gold plating works against the development of harmonised European laws, as each European directive becomes a mixture of different laws in each member state.
Time will tell how effective this Commission will be in living up to its ambitions, but it certainly has the means with two very practical tools.
The first tool is transparency. The Commission is to be commended for its adoption of a consultative approach in recent years. Not only does the Commission obtain useful market feedback on its proposals; this approach also allows it to tap market-specialist expertise in the very areas that it wants to legislate.
At Euroclear, we strongly believe the clearing and settlement industry has a moral obligation to contribute to the Commission’s education, particularly if it expects suitable legislative proposals. Very often, however, information is difficult for the Commission to obtain due to commercial or client confidentiality restrictions. Nevertheless, the fact remains that any proposals the Commission makes will be based on its understanding of the market and the way it works.
The second tool that the Commission has is the so-called regulatory impact assessment (RIA). This is not a new phenomenon. European policy makers have been systematically employing this analytical approach since 2003.
At the base level (and arguably the most effective), RIAs are cost-benefit analyses that look at the costs of implementing new rules against the benefits that should arise from them. It is commonplace, however, that precise benefits expressed in cash or savings are difficult to determine. Thus, other performance indicators might be used, such as the contribution of legislation to stability or risk mitigation. It is the latter approach that will probably be applied to the RIA currently underway on clearing and settlement in the EU.
The market must remain vigilant on how legislation is passed into practice. In particular, the data needed to populate the clearing and settlement RIA is not readily available. Here the Commission must depend on market experts for it, and these experts should be willing to provide it, if they can.
One such source of valuable information is the Commission’s advisory body known as the CESAME Group. This team of market practitioners and others was brought together by the Commission to assist and advise on the development of a single capital market for Europe. One clear objective of the Group is ‘to help the Commission assess the costs and benefits of removing the barriers and of providing an integrated environment in the EU’. Although the CESAME Group plays a pivotal role in informing the Commission of relevant subject matter, it only meets four times a year. Thus, it really falls to individual members to provide the Commission with detailed input.
An interesting observation published in 2004 by the European Policy Forum called ‘Reducing the Regulatory Burden: The Arrival of Meaningful Regulatory Impact Analysis’ noted that of the first 20 RIAs carried out by the Commission since 2003, every one found that a directive was needed. However, 10 of the proposed directives were modified to some extent to reflect the respective RIA’s conclusions, leading to what we surmise was more effective legislation.
What then of the possible directive on clearing and settlement, currently the subject of just such an RIA? Simply compiling the data to estimate the costs to the market of cross-border clearing, settlement and custody has taken months. The work to determine the impact of a directive on these costs is not likely to be any easier to achieve.
In fact, this RIA will be one of the first to be completed after the publication of the Commission’s green paper in May 2005. It will give us a solid view on if the Commission is meeting the challenges of the ‘Better Regulation’ agenda or whether, as some industry analysts feel, the RIA process is no more than an exercise to confirm the decision to legislate rather than analysing the need to do so.
At Euroclear, we welcome the European Commission’s proactive and transparent approach in seeking ways to reduce the risk and increase efficiency in cross-border clearing and settlement as outlined by the Giovannini Group. The work done by this group has been monumental in that it has identified the barriers preventing the formation of an efficient single capital market in Europe and has made specific industry groups and public policy makers responsible for removing them (see also link to 6148).
By removing these barriers, the costs of cross-border clearing, settlement and custody across Europe will be greatly lowered. The market is making substantial progress in this regard through market practice harmonisation and infrastructure integration/consolidation initiatives. We urge our public authorities to achieve similar progress in removing the legal and fiscal barriers. It is in these areas that future directives may well be needed.
At present, Euroclear remains unconvinced that a directive focused on the activities of settlement systems will reduce cross-border settlement costs. We agree with the European Parliament’s own report that a rigorous RIA is needed before any legislation is proposed. The report states that the European Parliament ‘is convinced that an unnecessary regulatory burden can best be avoided by giving careful attention to an analysis aimed at identifying those issues where rules may be needed’. The Parliament ‘welcomes the Commission’s decision to conduct an impact assessment which should include a thorough analysis of the potential costs and benefits of both legislative and non-legislative options’.
Now that the Parliament has adopted its own initiative report, the focus will turn back to the Commission, which is charged with delivering the RIA, probably during the first half of 2006. Assuming the Commission does decide to propose a directive, the proposal will then go back to the European Parliament and Council of Ministers, who will consult and finally vote on the need for, and the content of, new law.
Finally, notwithstanding the Commission’s commitment to a lighter regulatory programme, we should not be lulled into a false sense of serenity. There are still the ESCB-CESR standards to finalise and controversial aspects to address. New financial directives such as the MIFID and many others are about to be adopted into national law. The work of the Hague Convention on Conflicts of Law is also trying to make sense of which laws apply to whom and when.
Even with the best political will to reduce regulatory burdens as echoed by Internal Market Commissioner McCreevy recently, there is still a lot on our agendas. Nevertheless, if successful, the ‘Better Regulation’ agenda will be one of the most important contributions to the single European financial market. We must all encourage the EU authorities and our member state governments to make it happen.