Growth or pause in the European financial rulebook?
25 January 2024
EU financial regulation is at crossroads, grappling with a fundamental question: Will the single financial rulebook keep growing, or will it take a breather?
As we embark on 2024, the European Union is faced with significant changes in the financial services sector. Last time I outlined how under the leadership of Ursula von der Leyen, the European Commission proposed a staggering 42 legislative acts related to financial services from September 2019 to October 2023. This extensive legislative agenda, along with the adoption of broader acts affecting the sector, reflects the rapid expansion of EU financial regulations. However, this expansion, particularly through the ‘single rulebook’ concept established post the 2009 financial crisis, raises concerns about the potential for regulatory overreach.
The proliferation of these detailed regulations has implications not only for market participants but also for supervisory authorities.
The genesis of an ambitious regulatory architecture
The G20 Summit in Pittsburgh in September 2009, a response to the global financial crisis, focused on urgent financial regulatory reforms. Key initiatives included strengthening financial institutions’ resilience through enhanced capital buffers and reduced leverage, along with better regulation and supervision. The summit also led to the development of Basel III, which introduced higher standards for bank capital quality and quantity.
In October 2009, the European Parliament adopted a resolution reflecting on the outcomes of the Pittsburgh G20 Summit. It highlighted the significance of addressing global imbalances, identified as the root causes of the financial crisis, and emphasised the need for a holistic approach to prevent future crises. Nevertheless, the Parliament expressed its regret over the lack of thorough assessment of the major failures in regulation and supervision that led to the financial crisis. This omission was seen as a missed opportunity to avoid repeating similar regulatory and supervisory mistakes, potentially leading to another similar crisis. Additionally, the resolution voiced disappointment regarding the stagnation in efforts to finance the global fight against climate change.
Consequently, the Parliament strongly advocated for the European Union to work towards a more robust financial supervisory architecture, aiming for the establishment of a single financial supervisory authority. This was seen as a critical step in averting future financial crises through more centralised financial market supervision. Furthermore, it highlighted that the progress made within the broader context of the G20, characterised as ‘minimum harmonisation’, should not restrict the EU from implementing higher standards. In this vein, the resolution welcomed the European Union’s more ambitious stance regarding the scope and requirements of regulation and supervision. The European Parliament’s resolution, thus, underscored the necessity of substantive and effective global financial reform and regulation, not only as a means to safeguard against future financial crises but also to ensure the EU maintains a leading role in setting higher regulatory standards.
The 'Single Rulebook': broad, deep, and complex
In response to the global financial crisis, the European financial regulatory expansion is anchored by the ‘single rulebook’ concept, developed to harmonise regulations across the EU. This approach emphasises the consistent application of Basel III standards, leading to a detailed and comprehensive regulatory framework. As recently noted by the European Capital Markets Institute (ECMI), the framework is characterised by an array of Level 2 and Level 3 implementing measures, such as Regulatory Technical Standards (RTS) and Implementing Technical Standards (ITS). For instance, the extensive over 300 implementing measures in the CRR and CRD for banking, and the vast, over 30,000-page MiFID II framework for capital markets, underscore the Commission’s thorough and uniform regulatory approach.
The EU’s approach to regulation, characterised by its detailed and complex nature, distinctly sets it apart from other major jurisdictions, notably the UK and the US. This divergence stems from the EU’s unique structure and the necessity of ensuring a level playing field across its Member States. Consequently, the EU has extensively legislated through a co-decision procedure involving both the European Parliament and the Council. In contrast, the US has adopted a more principles-based approach, allowing supervisory agencies more discretion in implementation, with these agencies being accountable to Congress. Likewise, the UK, leveraging its common law system, is attempting to revert to a principles-based system. This contrast in regulatory approaches underscores the EU’s commitment to comprehensive legislation, as opposed to the more flexible, principle-focused methods prevalent in the US and the UK. This divergence underscores the unique challenges faced by the EU, fueling the debate on the manageability of its regulatory framework. It goes also without saying that, compared to the US and the UK, the EU legislates at a supranational level rather than a national one.
Considering the expanding regulatory framework, the European Commission’s Regulatory Fitness and Performance Programme (REFIT), a strategic initiative to streamline EU legislation, has focused on enhancing efficiency and reducing the burden on businesses since 2012, particularly targeting the simplification of financial regulations. This approach has led to significant reforms in key financial legislations such as the Prospectus Regulation, MiFID II, and the Market Abuse Regulation, facilitating easier access for SMEs to public markets. Despite these reforms, SMEs in the EU still primarily depend on bank loans for financing.
As a result, the Commission’s proposal for a Listing Act, introduced in December 2022, represents a further step in this direction. The Act is designed to reduce the regulatory hurdles that discourage SMEs from entering or remaining in regulated markets and SME growth markets. Key features of the Act include simplifying the documentation required for companies to list on public markets, streamlining the review processes by national regulators, and refining market abuse rules. Moreover, the Act proposes a new directive on multiple vote share structures, aimed at aiding controlling shareholders to maintain decision-making authority when listing their companies on SME-dedicated public markets.
The emphasis on reducing administrative burdens and the goal of decreasing reporting obligations by at least 25%, reflect a conscious effort to prevent the rulebook from becoming overwhelming. This approach, aimed at aligning sustainable finance regulations with industry realities, seeks to reduce complexities.
Europe in a global context
A focus on efficiency in my opinion is timely. As revealed in a recent report by OMFIF and Luxembourg for Finance, examining the loss of market shares of European financial services post-2008 financial crisis, there is a stark contrast in competitiveness between Europe and its global counterparts, notably the US and Asia. The report, focusing on key metrics like scale, diversification, profitability, pricing power, and valuation, highlights concerning trends such as the EU’s economy falling to 65% of the US’s in dollar terms, down from 91% in 2013. Specifically, the European banking industry’s market capitalisation plummeted from $2.7 trillion in 2007 to $1.4 trillion by 2021, in stark contrast to the US’s growth to $2.6 trillion. Similarly, in asset management, European firms’ share in the top 100 global investment funds dropped from 47% in 2007 to 22% in 2022, while the US’s share surged to over 70%.
This loss of market shares emphasises the urgent need to reassess the impact of financial regulations on the sector’s competitiveness, highlighting a crucial balance between regulatory burdens and the ability to finance the European economy.
In light of these findings, there is a pressing need for regulatory reform in the European financial sector to enhance its competitiveness. The report points to the fragmentation of Europe’s financial markets and the detrimental impact of the current regulatory landscape on the competitiveness of financial institutions. Prominent voices within the industry argue that these regulations hinder their ability to compete effectively on a global scale and fulfill their role in financing the European economy. Therefore, the report advocates for a reevaluation of financial regulations, urging a shift in perspective to understand how these regulations affect the banks’ competitive edge and their capacity to provide essential financing. This call for reform aligns with the European Commission’s initiatives, such as REFIT, being pivotal in reversing the downward trend and reinstating Europe’s position in the global financial landscape.
Charting the path ahead
As the European elections approach and with the potential for a new Commission, a key focus is the future of the single financial rulebook, balancing the need for comprehensive regulation with practical implementation. The Commission is considering a strategic and measured expansion of this rulebook, acknowledging the complexity of current regulations, the necessity to integrate new priorities, and the effects on market participants and authorities. At the same time, there’s a growing need to slow down the creation of new rules and concentrate on consolidating existing ones, particularly in the context of the Banking Union and Capital Markets Union (CMU). This dual approach suggests a crucial period for the EU financial sector, aiming for significant transformation while ensuring the regulatory framework remains effective without becoming excessively burdensome.