The New Wave of Regulations in Europe

International Financial Markets

Created byAbhijeet Singhal

1

Obje

ctives

• Reasons for Financial Crisis in the EU• How EU reacted to Financial Crisis• Financial Regulations Reforms in EU

and its member countries• What is being considered within

these regulations/ directives ?• Future Reforms in Financial

Regulations• Challenges Ahead• Conclusion• References

2

Reaso

ns fo

r Finan

cial C

risis

• Real Estate Bubble in the US• Failure of Regulatory Bodies in

– Stopping Excessive risk taking of Banks– Assessing Inter - Dependency of different

markets & institutions– Understanding Innovative Financial

Engineering such as Securitizations, Credit Risk transfer Collaterized Debt Obligations, Credit Default Swap etc.

– Supervising of large complex financial firms and credit rating agencies

– Compensation practices in Finance industries– Formulating the laws which can keep pace

with time and the financial markets progress

3

How

EU

reacte

d to

the

Crisis

• EU responses were slow when compared with the US in containing the crisis

• Made way to contain impact of financial crisis– Short term measures such as banning of

short selling and naked short selling etc.

• Planned to bring changes in how markets are regulated and supervised in 2009 and 2010– Structural Reforms in Financial Bodies– Medium and long-term measures such

as new Capital Requirements Directives, Market Abuse Directive revision etc.

4

Financia

l Reg

ula

tions R

efo

rms

in E

U

• Capital Requirement Directive II, 2009– Targets Liquidity risk management– Binding originators of securitization

products to retain its products’ 5% value “to keep them incentivized to continuously monitor credit risk”.

• Regulations for Credit Rating Agencies (CRA), from 2009 onwards– To prevent conflict of interest – getting paid

by issuer to getting paid by investors– To bring in liability for CRAs in analysis and

ratings given to various financial products– Monitoring of CRAs by European

Supervisory Authority – European Securities and Markets Authority (ESMA)

5

Financia

l Reg

ula

tions R

efo

rms

in E

U

• European Market Infrastructure Regulation (EMIR ), 2010– To stregthen stability within OTC derivative

markets– Reporting obligation for OTC derivatives– Clearing obligation for eligible OTC

derivatives– To standardise OTC derivative contracts

• Market Abuse Directive (MAD)revision, (Securities market), 2010– Improved transparency and integrity of

derivatives markets– Investor protection through strengthening

effective enforcement against market abuse

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Financia

l Reg

ula

tions R

efo

rms

in E

U

• Alternative Investment Fund Managers Directive (AIFMD), 2010– Brought Hedge funds and private equity

under the supervision of EU regulatory body just as pension and mutual funds

– Imposed limit to leverage for one time the amount of capital across a fund

– Minimum own fund requirement of €125,000 for external managed and €300,000 for self-managed funds.

7

Financia

l Regu

latio

ns

Refo

rms in

EU

• Central Counterparty Clearing (CCP) for OTC derivatives,2010– Prior to CCP, OTC derivatives were

traded one to one between parties without any intermediary – increased risk exposure to banks

– Mandatory to trade through CCP which reduces risks in case of defaults as CCP has to cover for the loss

– Companies not covered under clearing will be subject to stricter reporting

8

Financia

l Regu

latio

ns

Refo

rms in

EU

• Harmonization of key provisions of national deposit guarantee schemes, 2010 – To prevent negative arbitrage arising out of

different national deposit guarantee schemes

– Protection of retail and small investors interests

• Markets in Financial Instruments Directive (MiFID), review– To include newer trading platforms for

regulation and bring more derivatives onto organized markets

– Seek to increase transparency in pre- & post-trade market by stricter reporting

9

What is b

ein

g co

nsid

ere

d

with

in th

ese

reg

ula

tions/

dire

ctives ?

• Categorization of traders by type of regulated entity & by activity

• Inclusion of trading entities, financial instruments and markets under financial supervision

• Position reporting• Frequency of reporting• Time bound limits to reduce

volatility in exchange markets• Credit Position limits

– Individuals & Aggregate – Financial, index funds

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Post C

risis - EU

Financia

l S

up

erv

ision S

tructu

re

Macro-prudential supervision

Micro-prudential supervision

Members of ECB/ESCB

General Council

European Systemic Risk Board (ESRB)(Chaired by President ECB)

Chairs ofEBA, EIA& ESMA

European Commission

European System of Financial Supervision (ESFS)

European Banking Authority

(EBA)

EuropeanInsurance Authority

(EIA)

EuropeanSecurities and

MarketsAuthority(ESMA)

National BankingSupervisors

National InsuranceSupervisors

National SecuritiesSupervisors

+ +

Information on micro-prudential developments Early risk warning

Source: De Larosière Report, February 2009.

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EU

Financia

l Stru

ctura

l R

efo

rms

• Main Tasks of European Systemic Risk Council (ESRC)– Decide on macro-prudential policy– Provide early risk warning to EU supervisors– Compare Observations on Macro-economic and

prudential developments

• Main Tasks of European Supervisory Authorities (EBA, ESMA, EIA)– Legally binding mediation between national supervisors– Adoption of binding supervisory standards– Licensing and supervision of EU-wide institutions (e.g.

CRA, post trading infra.)– Binding cooperation with ESRC to ensure adequate

macro-prudential supervision

• Main Tasks of national supervisors– Continue to fully responsible for day-to-day supervision

of firms

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Financia

l Refo

rms in

Mem

ber

Countrie

s

• Most of member countries tried to plug in holes in the regulations which to prevent systematic risk and put all financial institutions under strict monitoring and regulatory institutions.– Adherence to EU policies and directives– Convergence on idea of tighter inter-border financial markets

control• Both Germany and the UK were taking actions in

accordance with CRD.• The UK

– Financial Service Authority (FSA) failed to regulate the market– Creation of Financial Policy Committee under Bank of England

to deal with supervision and regulation compliance of the system as a whole.

– Creation of Prudential Regulation Authority (PRA) to deal with regulating Financial institutions exposed to high risks

– Creation of Financial Conduct Authority to handle issues related to financial institutions

– FSA fears that too much interference in the markets will lead to exit of banks and financial companies

• Germany– Putting restrictions on short selling after the crisis– Making banks to retain 5% more than CRD II to make them

more accountable

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Futu

re R

efo

rms

• Focus on – Liquidity management – short and long term– Banking reforms – dependent on BASEL III– Remuneration structure in Finance sector– Monitoring and Supervision of Financial

Institutions

• CRD III (still being negotiated)– Remuneration principles to avoid excessive risk

taking– To tighten up the way in which banks assess the

risks connected with their trading book– New rules on highly complex financial products

(more capital retainment to cover their risks)– Disclosure of securitizations for market

confidence

• CRD IV– Regulations on short selling

• CRA regulations amendment

14

Ch

alle

ng

es A

head

• Lack of consensus between government regulators and markets as nobody knows how to respond to this relationship

• New regulatory bodies have no prior experience in handling regulation of such big market

• Functioning of National supervisors would be affected with creation of ESA

• Lack of single regulation body for supervision and monitoring across national supervisors

• Inter-connectedness of financial markets with world markets demands efficient and fast actions in future crisis

• Balancing financial market reforms and functioning of financial markets

• Fighting financial traders lobby who wants to thwart interference of governments in markets

15

Con

clusio

n

• EU and member countries definitely have a more robust approach towards financial markets reform than before.

• Continued and fast reforms keeping pace with the time and markets is necessary for preventing future crisis

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Refe

rence

s

• EU financial regulatory reform: a status report- Nicolas Veron, Bruegel Policy contribution, Dec 2010

• Capital Requirements Directive - Frequently Asked Questions, MEMO/09/335, 13th Jul 2009

• Report on The High-level group on Financial supervision in the EU chaired by Jacques de Larosiere, 25th Feb. 2009

• EU Commission (09/2010) Proposal for the regulation of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories, Brussels, European Union

• Regulating the Financial Markets: Lessons, Challenges, and Prospects in the Aftermath of the World Crisis - Howard Davies - Director, LSE, 12th Dec,2010

• Commodity derivatives reform in Europe - Dr Julian Oram - World Development Movement, 15th April 2011

• The new wave of Regulations paper – Martin Pathan, 16th Jun 2011• The MiFID Review – European Commission Consultation , Linklaters Stop Press,

Dec 2010• Summary of the impact assessment , Regulation of the European parliament

and of the council on OTC derivatives, CCP and trade repositories, Brussels, Sec (2010) 1059

• Regulatory Reform: A Primer, Nouriel Roubini and Elisa Parisi-Capone, 06.25.09, on www.forbes.com

• http://www.capital-requirements-directive.com/• http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/

10/659&format=HTML&aged=0&language=EN• http://www.financialstabilityboard.org• http://www.fsa.gov.uk/• http://www.bafin.de/• http://www.amf-france.org• http://www.ecb.int/home/html/index.en.html• http://ec.europa.eu/index_en.htm

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Thank you

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