Carmine Di Noia September 15 th , 2015

FINANCIAL MARKET LAW AND REGULATIONIntroduction and Basic Concepts,Law MakingSupervision and Enforcement Carmine Di Noia September 15th, 2015

Capital Markets Regulationin the EU Object of the course: the harmonized rules which govern capital (securities/financial) markets in the EU. We deal with market-based financial intermediation between suppliers of capital and firms seeking capital (no deposit taking institutions). Rules on issuers of securities, investment firms, investment funds, rating agencies and investment analysts, market infrastructures, such as trading venues and central clearing counterparties. How regulation and supervision is organized in the EU

Financial markets and instruments Definition/s: Markets – Intermediaries – Financial Instruments Banking, Securities, Insurance (further functional and timing differentiation) • Monetary (short term)/Capital (medium-long term) • Bond/equity (cash markets) • Capital/money/foreign exchange/derivatives • Primary/Secondary: different purposes • Retail/Wholesale • Internal/International • Regulated (and MTFs/OTFs)-trading venues/Unregulated (OTC) • Market Segments (Premium/Standard)

Financial Intermediaries • Banks, securities int., insurance firms, other (shadow banks, peer to peer banking, crowdfunding?)? • Banks: real time claim with sure nominal value • Commercial Banks/Investment banks • Dealing (Own account/on behalf of), Portfolio management, advisory services • Life Insurance • Issuers, investors/-holders and other market participants (financial analyst, rating agencies, ...)

Why do we regulate(/supervise)? Same reasons of public intervention in the economy: • Stability • Efficiency • Equity Market failures

Why do we regulate(/supervise)? • Macroeconomic Stability (Monetary Policy, LLR, Payment Systems, Settlement and Clearing, Wholesale Mkts) • Microeconomic Stability (Prudential Supervision, entry/exit controls, registers, capital requirements, limits to activities, controls on off-balance operations, protection schemes…) • Market Transparency and Investor Protection (conduct regulation, disclosure requirements,, homogeneous treatment, conflict of interest) • Efficiency: Safeguarding and Promoting Competition

The evolution of EU regulation Phase 1 Segré Report (1966), Coordination of Stock Exchange and Prospectus Laws 1979-82; Phase 2 White Paper on Completing the Internal Market (1985), mutual recognition/minimum harmonization/home member state control, passport regime, Harmonisation of Laws of Securities Markets 1988-93; Phase 3 Financial Services Action Plan (1999) (39 of 42 measures ok by 2004), Lamfalussy Report (2001), London Economics Report 2002 Phase 4 The post FSAP and the Legislative pause (2005-2010) Phase 5 The (post)financial crisis wave of EU new regulation: De Laroisère Report (2009) and new supervisory framework (ESAs ans SSM), Regulation of CRAs, EMIR and revision of the framework Directives (use of Regulations)

EU Commission Green PaperBuilding a Capital MarketsUnion • The challenges Investment in Europe remains heavily reliant on banks Significant differences in financing conditions between Member States exist There are differing rules and market practices for products like securitised instruments or private placements Shareholders and buyers of corporate debt rarely go beyond their national borders when they invest Many SMEs still have limited access to finance • The objectives Develop a more diversified financial system complementing bank financing with deep and developed capital markets Unlock the capital around Europe which is currently frozen and put it to work for the economy, giving savers more investment choices and offering businesses a greater choice of funding at lower costs Establish a genuine single capital market in the EU where investors are able to invest their funds without hindrance across borders and businesses can raise the required funds from a diverse range of sources, irrespective of their location Action Plan? After September 30th?

Sources of the EU capital market legal framework - 1 • Treaty on the European Union (TEU) (art. 3(3) “The Union shall establish an internal market”). • Treaty on the Functioning of the EU (TFEU) (art. 26 1. The Union shall adopt measures with the aim of establishing or ensuring the functioning of the internal market, in accordance with the relevant provisions of the Treaties. 2. The internal market shall comprise an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured in accordance with the provisions of the Treaties). • Basis: Freedom to provide services (56-62 TFEU), freedom to establish (49-55 TFEU) • If regulatory competition not sufficient: adoption of harmonized rules, single rulebook, regulatory powers at EU level…

Sources - 2 • Treaties’ law-making institutions with ordinary legislative procedure: Commission proposal adopted by the Council of Ministers (Ecofin) and Parliament (289, 294 TFEU). Extensive technical administrative rules adopted by the Commission (290-291 TFEU) with ESMA engaged to different degrees • Under 288 TFEU, 3 forms of EU binding rules: Directives, Regulations and Decisions • Minimum/Maximum Harmonization: Implementation • Enforcement: Court of Justice • Level 1 or 2, Comitology

Sources - 3 • Soft (?) law: • Commission Communications, Recommendations,.... • FAQ, Q&A, • (CESR/ESMA) Guidelines, Public Statements (!) e.g. Acting in concert)

Figure 1. The Lamfalussy Structure L1 Legislation Council Commission Parliament ESC1 EIOPC1 EBC1 L2 Implementing details CEIOPS3 CEBS2 CESR3 L3 Guidelines Commission L4 Enforcement EBC = European Banking Committee ESC = European Securities Committee EIOPC = European Insurance and Occupational Pensions Committee CEBS = Committee of European Banking Supervisors CESR = Committee of European Securities Regulators CEIOPS = Committee of European Insurance and Occupational Pensions Supervisors ¹ Finance ministries ² Supervisors and Central Banks ³ Supervisors IIMG SUPERVISION

De Laroisere report De Laroisère Report proposes EBA, ESMA and EIOPA as micro (?) supervisory (?) entities and ESRB for macroprudential (“city” reasons? London, Frankfurt, Paris) But the regulatory framework should evolve “towards a system which would rely on only two Authorities: The first would be responsible for banking and insurance issues, as well as any other issue which is relevant for financial stability (e.g. systemically important hedge funds, systemically important financial infrastructures). The second Authority would be responsible for conduct of business and market issues, across the three main financial sectors. Combining banking and insurance supervisory issues in the same Authority could result in more effective supervision of financial conglomerates and contribute to a simplification of the current extremely complex institutional landscape” (point 216, p. 58)

The EU ESAs supervisory structure European Systemic Risk Board (ESRB) • Members of the General Board without voting rights: • Representatives of national supervisors • President of the Economic and Financial Committee Macro-prudential supervision + • General Board • ECB President and vice-President • Governors of national central banks • a Member of the European Commission • Chairpersons of the three European Supervisory Authorities • Chairs and the two vice-Chairs of the Advisory Scientific Committee • Chair of the Advisory Technical Committee Macro-prudential information, early risk warnings and recommendations to supervisors Micro-prudential information Micro- prudential supervision SSM + European Banking Authority (EBA) European Insurance and Occupational Pensions Authority (EIOPA) European Securities and Markets Authority (ESMA) European Supervisory Authorities (ESAs)

1. ESAs at work The creation of ESAs as EU Authorities on 1 January 2011 through the 3 ESAs Regulations: some changes regarding how the four level legislative procedure works: Level 1 Directives and regulations, continue to set out the high level political objectives on the area concerned by the legislation. Occasionally, at this early stage, ESAs may be asked for technical advice by the Commission as it develops its legislative proposal. ESAs’ greater role in Level 2 in drafting delegated acts and implementing acts. Delegated acts are concerned more with the substantive content of the legislative requirement, for example setting out what authorisation information firms must provide to competent authorities. Implementing acts are similar to executive measures giving effect to the substantive requirements, this might include for example, standard forms, templates and procedures for communicating information or processes between competent authorities.

2. ESAs at work At Level 3, ESAs will develop guidelines and recommendations with a view to establishing consistent, efficient and effective supervisory practices within the European System of Financial Supervision, and to ensure the common, uniform and consistent application of Union Law. The guidelines and recommendations are addressed to competent authorities or financial market participants. Whilst not legally binding, these have been strengthened under ESAs and competent authorities must now make every effort to comply and must explain if they do not intend to comply. Financial market participants can also be required to report publically whether they comply. ESAs will also take other steps under Level 3 to ensure supervisory convergence.

3. ESAs at work At Level 4, a fast track procedure has been introduced by the Regulation establishing ESAs. On this basis, ESAs now have a new role. At the request of a national competent authority, the European Parliament, Council, Commission or the Stakeholder Group, ESAs can be requested to launch an enquiry and can issue a recommendation addressed to the national authority, within two months of launching its investigation. ESAs will also be able to launch investigations on its own initiative. The Commission will also be able to follow its usual procedures for referring a case against the Member State to the Court of Justice.

ESMA governance and procedures - 1 Esma is (not) an agency. “Union body with legal personality”, degree of independence, established under secondary EU law, designed to inject expert technical capacity into the rule making process But: BTS (binding technical standards) proposal powers. Regulatory powers: RTS and ITS Guidelines and Recommendations Supervisory powers

ESMA governance and procedures - 2 The governance of ESMA Board of Supervisors (BoS): 28 national authorities, a (non-voting) chairman, one observer from the European Commission, from Norway, Iceland and Lichtenstein, a representative of EBA and EIOPA and one representative of the ESRB. Take all policy decisions, such as decision on the compliance by national competent authorities with community legislation, interpretation of community legislation, decisions in crisis situations, the approval of draft technical standards, guidelines, peer reviews and any reports which are developed. Management Board: (Voting) ESMA chair, 6 members from Bos, 3 observers (Executive Director and EU Commission and ESMA deputy chair ) Chairman and Executive Director Securities and Markets Stakeholder Group (SMSG) Joint Bodies: Joint Committee of ESAs and Board of Appeal

ESAs Review Common review clause of ESAs by January 2nd 2014 (art. 81.2 ESAs Regulations). Appropriateness of separation of banking, insurance, securities and financial markets and separation of prudential supervision and business conduct; coherence in ESFS of macro and micro levels and between the ESAs; move ESAs to a single seat The ESAs report identifies several areas for improvement: ESAs should give a higher profile to issues related to consumer/investor protection, and strengthen the focus on supervisory convergence, with better use of peer reviews. Long term: governance of the ESAs, in particular to further improve the capacity of the Board of Supervisors to take decisions in the interest of the EU as a whole.

Why a banking/financial union • Financial markets in the EU have increasingly reached a cross-border dimension, banks and other financial intermediaries too big and too interconnected • Regulation still fragmented, multiple rulebooks; ECB offers liquidity support to the system but does not dispose of supervisory power; deposit guarantee schemes, crisis management/resolution and supervision are still only at national level • Such asymmetry exposes the financial system to risks of instability and retrenchment within national borders when a crisis strikes • Too late for having (regulation and) supervision ONLY at national level. • Too early (and crazy and expensive) to have supervision ONLY at the central level 27

“Optimal” Model? • Different for industrial, emerging and developing countries. • Path-dependence: any reform starts from a status quo, and this is often “hybrid”, characterized by the adoption of regulatory regimes that mix different elements of the models above. • The debate focuses on: a) centralizing powers and responsibilities versus maintaining a mainly domestic view, b) choosing a regulatory model (currently in the single countries).

However… • Not necessarily harmonization means full centralization. The Euro area (but UK?) may be too large for only one (or more) central regulator (s) • Too many different national rules exist (commercial codes, company laws, insolvency procedures, corporate governance) • Fiscal policies still not harmonized • In many cases, national enforcement might still be desirable • Too early for full centralization….too late for complete decentralization

Domestic regulation/supervision still good? • One currency (but not UK), one monetary policy.....different FM rules? Consolidated regulation • How to deal with financial groups and conglomerates? Need some consolidated supervision (more than lead regulator) • Incentives for policy makers and regulators to compete in regulatory or supervisory laxity in order to attract more firms and funds locally. At the same time, it is not clear who will pay the costs of insolvency. And it is not clear how a solvency (or even a liquidity) crisis will be managed. • Hence…More Harmonization in FMR is needed as FM integration goes on (M&A among exchanges, internet, X-border mergers among intermediaries, dual and X-border offerings and listings), in order to promote further integration

ESAs Review: some proposals - 1 Financial Union for EU countries (or opt-out for non euro countries; ECB can be a lender of last resort only for countries where it is the central bank) Federal model: central regulation, national supervision for all entities but cross-border and (even non banking) Sifi. Supervisory Standards and Single rulebook at central level. … 4-peaks (separating macro and micro stability, investor protection and competition); cancel one ESA

4-peaks with macrostability to ECB and ESCB and microstability: prudential regulation and supervision separated from (subsidiary?) ECB European System of Prudential Supervision European System forInvestorProtection European System ofCentralBanks European System forCompetition Euro Level CoordinationCommittee ECB (and ESRB) Frankfurt European Prudential Authority London/Frankfurt European Investor Protection Authority Paris European Antitrust Authority Bruxelles National Level CoordinationCommittee National CentralBanks Prudential Supervisory Authority InvestorProtection Authority Antitrust Authority

ESAs Review: some proposals - 2 Governance of central agencies similar to ECB: Management Board with 6 independent members (including the chairman) appointed by EU Commission, EU Parliament opinion, Chairman (casting) vote Extension of direct supervisory powers Extension of ESMA scope to art. 1(3) for implementing standards, breach of EU Law and settlement of disagreements National coordination committees at national and central level with policy makers (and EU Commission)

Appendix:How do we regulate at national level • INSTITUTIONAL (sectoral) • REGULATION BY OBJECTIVE (Prudential supervision/conduct of business) • SINGLE REGULATOR (integrated) • FUNCTIONAL - by activity

Financial regulation/supervision CB (Central bank), PA (Prudential Authority on banks, securities and insurance, different from CB), B (Prudential Agency for banks), IP (Investor protection Authority for banks, securities and insurance), S (Securities Authority), I (Insurance Authority), PF (Pension Fund Authority), IPF (Insurance and Pension Fund Authority), FSA (Single prudential and investor protection regulator), G (Government department), CA (National Competent Authorities)

A model: UK as of April 1° 2013 Bank of England Protecting and enhancing the (macro)stability of the UK financial system Financial Policy Committee (committee of BoE) Contributing to the Bank’s financial stability objective through MACRO-PRUDENTIAL regulation FPC powers of recommendation and direction Financial Conduct Authority (company limited by guarantee) Conduct regulation (and supervision), markets, issuers, prudential regulation of non-PRA firms Prudential Regulation Authority (subsidiary BoE) Firm-specific prudential regulation (and supervision) MACRO/MICRO prudential regulation/supervision MICRO-PRUDENTIAL regulation/supervision CONDUCT regulation/supervision prudential & conduct regulation/supervision Systemic infrastructure(central counterparties, settlement systems and payment systems) prudentially significant firms (banks, insurers and major investment firms) smaller investment firms & exchanges, other financial service providers

Carmine Di Noia September 15 th , 2015