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Financial sector Regulation

The Commission has taken measures and made proposals to reform and strengthen the EU's financial services sector so as to restore lending to the economy and to reduce the chances of future problems. These measures also ensure the integrity of the EU's Single Market for financial services by ensuring that action taken by Member States' regulators is coordinated and coherent.

  • As part of this, new pan-EU supervisory authorities have been set up – the European Banking Authority in London, the European Securities Markets Authority in Paris, the European Insurance and Occupational Pensions Authority in Frankfurt and the European Systemic Risk Board in Frankfurt.
  • The European Banking Authority (EBA) has supervised annual stress tests to assess the ability of 90 systemically important banks in 21 countries to withstand potential financial shocks.
  • On the basis of the 2011 stress test results, announced on 15 July 2011, the EBA recommended that national supervisory authorities should require banks whose ratio of core "tier one" capital (as defined by the Bank for International Settlements' Basel Committee on Banking Supervision) to risk-weighted assets fell below 5% or was only slightly above 5% to boost their capital reserves. These capital adequacy ratios are designed to ensure that banks have the necessary minimum levels of capital to cover potential losses while still honouring withdrawals.
  • On October 26, 2011 the European Banking Authority indicated that banks are required to build up additional capital reserves so as to ensure that their core "tier one" capital ratio reaches 9% by the end of June 2012.
  • The Commission's proposals for a Directive and Regulation on capital requirements, presented in July 2012, would implement into EU law these higher minimum capital requirements, which are based on the latest recommendations from the Basel Committee (known as Basel III). The proposals would also give supervisors new powers to monitor banks more closely and take action through possible sanctions when they spot risks, for example credit bubbles.
  • To regulate the activities of hedge funds, the Commission proposed the Alternative Investment Fund Managers (AIFM) Directive in April 2009. Adopted by the European Parliament and the EU's Council of Ministers in November 2010, the Directive is due to be implemented by Member States in 2013. The Directive will:
    • increase transparency for investors, supervisors and the employees of the companies in which hedge funds and other alternative investment funds invest
    • equip national supervisors, the European Securities Markets Agency ("ESMA") and the European Systemic Risk Board ("ESRB") with the information and tools necessary to monitor and respond to risks to the stability of the financial system that could be caused or amplified by hedge fund activity
    • introduce a common and robust approach to the protection of investors in these funds
    • ensure that these funds can operate on an equal footing throughout the Single Market, thereby creating the conditions for increased investor choice and competition in the EU, subject always to high and consistent regulatory standards and
    • increase the accountability of AIFM holding controlling stakes in companies (private equity) towards employees and the public at large.

Firewalls to protect the euro (EFSM, EFSF, ESM)

At the initiative of the European Commission, the EU's Member States have agreed to put in place so-called 'firewall' confidence-building measures to help to finance the debts of countries facing temporary difficulties in borrowing money from financial markets.
These comprise:

  • The European Financial Stability Mechanism – allows the European Commission to borrow up to €60 billion from financial markets on behalf of the EU to lend to any EU country in difficulty. Countries receiving loans have to submit a macroeconomic adjustment programme to restore to financial markets' confidence in their ability to repay their debts financial stability and to restore long term competitiveness. They have to repay the amount of money borrowed, plus the interest payable to financial markets. Since the Mechanism was set up in May 2010 it has loaned €48.5 billion (€26 billion to Portugal and €22.5 billion to Ireland) repayable within three years.
  • The European Financial Stability Facility- an emergency fund of €440 billion guaranteed by euro area countries to lend money to euro area countries that have difficulties to borrow from financial markets, recapitalise troubled banks and buy the debt of countries in difficulty. The Facility finances itself by borrowing from financial markets. It was set up by eurozone Finance Ministers in May 2010 and has so far lent some €18.92 billion (€9.6 billion to Portugal and €9.32 billion to Ireland).

EFSF contribution key in %
Even if used to its full extent, EFSF would represent roughly just €2500 for every man, woman and child in the Euro zone. Below the contribution key in percentage of total contribution can be seen.

  • The European Stability Mechanism - - this new Mechanism is due to take over the functions of the two existing instruments (EFSF and EFSM) as of July 2012. Its lending capacity is currently set at €500 million. From March 2013, financial assistance under the ESM will be available to eurozone and non-euro area countries that have ratified the Fiscal Compact Treaty and have also implemented a balanced budget rule. Countries will only be eligible for financial assistance from the Mechanism if it is considered necessary to ensure the financial stability of the euro area as a whole. Any euro area Member State receiving assistance will have to implement a macro-economic adjustment programme, conduct a rigorous analysis of public-debt sustainability, and foresee IMF participation in liaison with the ECB. The ESM could, exceptionally, decide to purchase bonds issued by an ESM Member State if this maximised the cost efficiency of the financial assistance.

Fiscal Compact Treaty

The Fiscal Compact Treaty (i.e. the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union) signed by 25 Member States (all except Czech Republic and UK) and due to enter into force once 12 Member States have ratified it (and no later than 1 January 2013).
The Treaty:

  • further strengthens the rules on enforcing rules on budget deficits and economic policy coordination laid down in the so-called 'six pack' and proposed in the so-called 'two pack' by incorporating them in primary legislation (an intergovernmental Treaty)
  • requires signatory countries to report their public debt issuance plans to the Commission and to the Council
  • requires signatory countries to coordinate among themselves and with the EU institutions in advance of all major economic reforms planned
  • requires signatory countries to support Commission recommendations to the EU's Council of Ministers on countries with excessive budget deficits unless a qualified majority of Member States opposes them.
  • requires signatory countries to adopt laws, either at constitutional level, or be similarly binding, to maintain structural deficits (i.e. the share of a country's budget deficit that would remain after its economy recovered to normal levels of output) of no more than 0.5% of their nominal GDP. If a signatory country deviates from this rule, an automatic correction mechanism will be triggered.
  • requires signatory countries to accept the jurisdiction of the EU's Court of Justice to verify the implementation of such a constitutional law to limit structural deficits and to impose a fine of up to 0.1% of a country's GDP if such a law were not implemented.
  • limits financial assistance from the European Stability Mechanism, as of 1 March 2013, to countries that had enacted the Treaty.

Fiscal Union

Within the Euro area greater pooling of decision-making on budgets, pooling of risks and the establishment of effective mechanisms to prevent and correct unsustainable fiscal policies in each Member State are essential.

Under such plans, upper limits on the annual budget balance and on government debt levels of individual Member States could be agreed in common. Issuance of government debt beyond levels agreed in common would have to be justified and receive prior approval.