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Financial regulation and supervision inthe European Union after the crisisLucia Quaglia aa University of York UKVersion of record first published 17 Jan 2013

To cite this article Lucia Quaglia (2013) Financial regulation and supervision in the EuropeanUnion after the crisis Journal of Economic Policy Reform 161 17-30

To link to this article httpdxdoiorg101080174878702012755790

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Financial regulation and supervision in the European Union after thecrisis

Lucia Quaglia

University of York UK

The global financial crisis challenged the existing architecture for financial servicesregulation and supervision in the European Union (EU) This article first examines thenew pieces of legislation that were issued by the EU in the wake of the crisis as wellas substantial revisions of existing EU legislation Second it conducts an overallassessment of the reforms implemented and highlights some open issues that wereunderscored by the crisis and that were only partially addressed afterward It is arguedthat the framework for financial regulation and supervision in the EU after the crisis isstill poorly equipped to deal with (or to prevent) future financial crises mainly becauseof the political constraints encountered during the reform process One of the mostimportant lessons to be drawn is that political factors are as important as (if not moreimportant than) economic factors in shaping financial services regulation and supervi-sion in the EU (and arguably elsewhere)

Keywords financial regulation financial supervision European Union (EU)regulatory reforms

1 Introduction

The global financial crisis that erupted full force in late 2008 challenged the existingarchitecture for financial services regulation and supervision in the European Union (EU)as well as in other jurisdictions such as the US (see the Dodd-Frank act) This articlefirst examines the new pieces of legislation that were issued by the EU in the wake ofthe crisis as well as substantial revisions of existing EU legislation Second it highlightssome open issues that were underscored by the crisis and were only partially addressedafterward explaining why this was the case The article does not discuss the sovereigndebt crisis as such (which is primarily related to fiscal policy not financial regulation)although it elucidates the circular link between the financial (meaning banking) crisisand the sovereign debt crisis

Before examining how the EU has responded to the crisis it is useful to spell outwhat needed to be done setting a benchmark to assess the current progress First the cri-sis partly originated and was substantially worsened by financial activities or financialinstitutions that prior to the crisis were not properly regulated or were de facto unregu-lated in the EU in other jurisdictions (eg the US) andor internationally Hence thescope of EU financial regulation was to be extended and its content made less lsquomarket-friendlyrsquo Second the crisis highlighted the problem of sharing the costs of recapitalisingor winding down ailing cross-border financial institutions especially in the deeply

Email luciaquagliayorkacuk

Journal of Economic Policy Reform 2013Vol 16 No 1 17ndash30 httpdxdoiorg101080174878702012755790

2013 Taylor amp Francis

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integrated European financial market An EU mechanism to deal with cross-border ailingbanks was needed Third the crisis underscored the importance of macroprudential super-vision in the EU as well as in other jurisdictions (eg the US) (on the spread of macro-economic ideas see Baker 2012) Financial supervision was to be reformed in light ofthis

The article argues that financial regulation and supervision in the EU after the crisisare still poorly equipped to deal with (or to prevent) future financial crises mainlybecause of the political constraints (of various kinds) encountered during the reform pro-cess One of the most important lessons to be drawn from this case study is that politicalfactors are as important as (if not more important than) economic factors in shaping theframework for financial services regulation and supervision in the EU (and elsewhere)

2 The reform of financial regulation and supervision in the EU

A host of new regulatory initiatives were undertaken by the EU in the aftermath of theglobal financial crisis besides the short-term crisis management measures adopted in themidst of the turmoil (Quaglia et al 2009) The new rules introduced or substantiallyamended mainly concerned banking securities markets and financial supervision eventhough certain legislative measures cannot easily been pigeonholed in one of these cate-gories The EUrsquos actions that have not resulted in lsquohardrsquo legislative measures such as theRecommendation on Remuneration Policies (Commission of the European Communities2009) are not examined here because they are not legally binding

Banking regulation in the EU

Directives on Deposit and Investor guarantee schemes

As far as banking is concerned the global financial crisis brought into the spotlight theinadequacy of the existing Deposit Guarantee Scheme (DGS) directive dating back to1994 This directive set the minimum level of deposit protection schemes in the EU toe20000 per depositor When the crisis broke out the depositor protection coverage ran-ged from e20000 in the new member states and the UK to more than e100000 in Italyand France Moreover uncoordinated decisions on deposit guarantees taken by somemember states worsened the crisis

At the peak of the crisis the Commission proposed legislative changes concerning theDGS directive These changes which were agreed in a rush in 2009 represented anemergency measure designed to restore depositorsrsquo confidence by raising the minimumlevel of coverage for deposits from e20000 to e50000 and subsequently to e100000The need for swift action meant that several open issues were not tackled and hence thedirective contained a clause providing for a broad review of all aspects of DGSs

In July 2010 the Commission put forward a legislative proposal on DGS for bankswith a view to addressing the remaining issues (Commission 2010a) The proposed direc-tive contained measures for the harmonisation of coverage and the simplification ofarrangements for payout One of the most contentious provisions was the establishmentof a mandatory mutual borrowing facility whereby if a national deposit guarantee schemeis depleted it can borrow from another national fund Several member states tried to takethis provision out while discussing this piece of legislation in the Council The mutualborrowing facility could be the first step towards a pan-EU deposit guarantee schemewhich was even more controversial Indeed in the preparation of the directive the

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Commission considered the setting up of a single pan-European scheme However itsoon realised that there were complicated legal issues that needed to be examined andtherefore the idea of a pan-European DGS was temporarily shelved Ultimately howeverthe problem was political The creation of a pan-European DGS would have impliedpooling national sovereignty to an extent not acceptable to the ember states as explainedin Section 3 A report examining this issue will be presented by the Commission by2014 (Commission 2010a)

The directive on DGS for banks was part of a package on guarantee schemes in thefinancial sector which also comprised a review of investor compensation schemes (Com-mission 2010b) and a White Paper on insurance guarantee schemes (Commission 2010c)all issued in July 2010 The Investor Compensation Scheme directive dating back to1997 established a minimum level of compensation in cases where an investment firmwas unable to return assets belonging to an investor The Commissionrsquos proposal for arevision of this directive raised the minimum level of compensation for investors frome20000 to e50000 per investor The payout time was reduced to up to 9 months Theapproval of these pieces of legislation is pending

Capital requirements for banks and investment firms

Capital requirements for banks have traditionally been regarded as one of the main instru-ments to ensure the stability of the banking sector and hence financial stability tout courtIn 1988 the Basel Committee on Banking Supervision (BCBS) issued the Basel I Accordon lsquoInternational convergence of capital measurement and capital standardsrsquo which wasupdated by the Basel II Accord in 2004 Over time these lsquosoftrsquo international rules havebeen incorporated into (legally binding) national legislation in more than 100 countriesIn the EU this has been done through the capital requirements directives (CRD)

Various revisions of the CRD were carried out in parallel with the international debateon this issue taking place in the BCBS when the crisis broke out The revisions of theCRD in 2009 and 2010 set higher capital requirements on the trading book and re-securi-tisations imposed stronger disclosure requirements for securitisation exposures andrequired banks to have sound remuneration practices that did not encourage or rewardexcessive risk-taking The scope of these changes however remained quite limitedbecause a comprehensive revision of the Basel II accord was pending

The Basel III accord was signed by the BCBS in December 2010 (Basel Committeeon Banking Supervision 2010ab) The new rules provide a more restrictive definition ofwhat counts as capital increase the risk weight of several assets in the banking book andintroduce capital buffers set up a recommended and potentially obligatory leverage ratioand outline international rules on liquidity management All in all the new rules increasethe proportion of capital that must be of proven loss absorbing capacity (going concern)ie core tier one (equity) capital over Basel II requirements and will be phased in gradu-ally from January 2013 until 2019

Once the Basel III accord was agreed internationally the process of incorporating itinto EU legislation began in earnest In July 2011 after extensive consultation conductedin parallel with the work of the BCBS the EU Commission adopted the CRDIV legisla-tive package designed to replace the CRDIII with a directive that governs the access todeposit-taking activities (Commission 2011a) and a regulation that establishes prudentialrequirements for credit institutions (Commission 2011b) After its approval the proposeddirective (Commission 2011a) will have to be transposed by the member states in a waysuitable to their own national environment It contains rules concerning the taking up and

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pursuit of the business of banks the conditions for the freedom of establishment and thefreedom to provide services the supervisory review process and the definition of compe-tent authorities The directive also incorporates two elements of the Basel III accordnamely the introduction of two capital buffers on top of the minimum capital require-ments the capital conservation buffer identical for all banks in the EU and the countercy-clical capital buffer to be determined at national level The proposed EU regulation(CRR) (Commission 2011b) contains prudential requirements for credit institutions andinvestment firms The proposed regulation covers the definition of capital increasing theamount of own funds that banks need to hold as well as the quality of those funds itintroduces the Liquidity Coverage Ratio ndash the exact composition and calibration of whichwill be determined after an observation and review period in 2015 and the need to con-sider a leverage ratio subject to supervisory review

The Commissionrsquos CRDIV draft was criticised for watering down or modifying theBasel III guidelines in ways to meet EU member state demands (International MonetaryFund 2011) The Commission lsquosoftenedrsquo its definition of Core Tier I capital relative tothe Basel III recommendations in some areas For example it allowed lsquosilent participa-tionsrsquo that is state loans that make up a significant part of public Landesbanken capitalin Germany The Commissionrsquos draft limited the role of the leverage ratio designed tolimit risk-taking at banks On liquidity the Commissionrsquos draft adopted a less prescriptivedefinition of liquid assets and lacks a firm commitment to implement the Net StableFunding Ratio The proposed regulation also sets higher capital requirements for Overthe Counter (OTC) derivatives that are not cleared through Central Counterparties

The use of a regulation which once approved is directly applicable without the needfor national transposition was designed to ensure the creation of a single rule book inthe EU The regulation eliminates a key source of national divergence In the CRD IImore than 100 national discretions (differences in national legislation transposing the EUdirective) remained The Commission also proposed a maximum capital ratio that wasopposed by those such as UK policy-makers who argued in favour of EU standards thatexceed the Basel minimum Indeed in the negotiations of the new capital requirements inBasel and Brussels British policy-makers favoured strict rules on capital and liquidityBy contrast French and German policy-makers supported lsquosofterrsquo rules These memberstates the European Parliament (EP) and the Commission called for taking into accountlsquoEuropean specificitiesrsquo in incorporating the Basel III rules into the CRD IV reopeningsome of the issues that had caused friction within the BCBS Indeed the ongoing negoti-ations of this legislation are slowed down by different national preferences across themember state which in turn are due to the likely effects of the new rules in the memberstates (Howarth and Quaglia forthcoming)

Directive establishing the framework for the recovery and resolution of credit institutionsand investment firms

During the financial crisis several large banks were bailed out with public funds becausethey were considered lsquotoo big to failrsquo In June 2012 the Commission adopted a legislativeproposal for bank recovery and resolution (Commission 2012b) designed to avoid govern-ment bailout of large banks in the future The scope of application of the proposal was thesame as the CRD discussed above hence it applied to all credit institutions and certaininvestment firms The proposal distinguished between powers of lsquopreventionrsquo lsquoearly inter-ventionrsquo and lsquoresolutionrsquo In the case of prevention banks are required to draw up recoveryplans and resolution authorities are required to prepare resolution plans both at group level

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and for the individual institutions within the group Authorities can require a bank tochange its legal or operational structures to ensure that it can be resolved with the availabletools Financial groups may enter into intra-group support agreements in the form of loansor the provision of guarantees The framework envisages early supervisory interventionwhereby the authorities could require banks to implement measures set out in the recoveryplan and would have the power to appoint a special manager at a bank for a limited period

The harmonised resolution tools and powers outlined in the directive are designed toensure that national authorities in all member states have a common toolkit and roadmapto manage the failure of banks Amongst the tools considered there is the bail-in toolwhereby banks would be recapitalised with shareholders wiped out or diluted and credi-tors would have their claims reduced or converted to shares Resolution colleges are tobe established under the leadership of the group resolution authority and with the partici-pation of the European Banking Authority (EBA) The EBA will facilitate joint actionsand act as a binding mediator if necessary

The legislation envisaged the creation of resolution funding which would raise contri-butions from banks proportionate to their liabilities and risk profiles and would not beused to bail out a bank There is a link between this piece of legislation and the directiveon DGS which will provide funding for the protection of retail depositors Member stateswill be allowed to merge these two funds provided that the scheme remains in positionto repay depositors in case of failure The Commission noted that ideally a single pan-European fund should be established with a pan-European resolution authority to manageits disbursal but the absence of a single European banking supervisor and insolvencyregime would make this unworkable1 As in the case of the DGS the obstacles to thesefar-reaching changes were ultimately political as explained in Section 3 and negotiationsare ongoing

Securities markets regulation in the EU

Regulation on Credit Rating Agencies

In the securities sector Credit Rating Agencies (CRAs) were singled out amongst the mainculprits of the crisis for failing to rate properly financial products (Brunnermeier et al2009) They substantially over-rated many complex securities created through the financialactivity of securitisation and were slow in revising their ratings once market conditionsdeteriorated The over-generous rating of securities was influenced by the strong competi-tion taking place between CRAs in order to attract clients and by conflicts of interestbecause CRAs provided a variety of other services to the potential issuers requiring ratinghence they had strong incentives to be generous in their assessment of creditworthiness

Prior to the crisis CRAs were regulated internationally by a voluntary Code of Con-duct Fundamentals issued by IOSCO in 2004 and revised in the wake of the crisis in2008 The EU had considered and then ruled out specific EU rules on CRAs (Muumlgge2011) After the crisis the French presidency of the EU in the second semester of 2008implicitly made EU legislation on CRAs one of its priorities The European Council calledfor a legislative proposal to strengthen the rules on credit rating agencies and their supervi-sion at EU level in October 2008 (Quaglia 2009) Influential MEPs supported the regula-tion of CRAs in the EU The (revised) IOSCO Code provided the benchmark for theCommissionrsquos draft regulation on CRAs However the Commission argued that theIOSCO rules needed to be made more concrete and be backed by enforcement (Moschella2011 Pagliari 2011)

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The Regulation on CRAs was agreed relatively quickly by the EU in less than a yearAccording to the new rules all CRAs whose ratings are used in the EU need to applyfor registration in the EU and have to comply with rules designed to prevent conflict ofinterest in the rating process and to ensure the quality of the rating methodology and theratings CRAs operating in non-EU jurisdictions can issue ratings to be used in the EUprovided that their countries of origin have a regulatory framework recognised as equiva-lent to the one put in place by the EU or that such ratings are endorsed by an EU-regis-tered CRA (Council of Ministers and European Parliament 2009)

In June 2010 the Commission proposed an amendment of the Regulation on CRAsadopted in 2009 Since ratings issued by a CRA can be used by financial institutionsthroughout the EU the Commission proposed a more centralised system for supervisionof CRAs whereby the newly created European Securities and Markets Authority (ESMAdiscussed below) was entrusted with exclusive supervisory powers over CRAs registeredin the EU including European subsidiaries of US-headquartered CRAs such as FitchMoody and Standard amp Poor The ESMA was given powers to request information tolaunch investigations and to perform on-site inspections The amended regulation wasadopted by the Council and the EP in May 2011 (Council of Ministers and European Par-liament 2011) In the summer of 2011 the downgrading of the government bonds in thecountries directly hit by the sovereign debt crisis by the (mainly US-headquartered)CRAs gave new momentum to the debate on the creation of the European rating agencya proposal that was put forward by the EP

Alternative Investment Funds Managers Directive

The attempt to regulate hedge funds in the EU was given new momentum by the finan-cial crisis (see Broby 2012) In June 2009 the European Commission presented its pro-posal for the draft directive on AIFMs (Alternative Investment Funds Managers) whichincluded managers of hedge funds private equities funds and real estate funds hencecovering quite a broad range of financial entities The main sponsors of the directive wereFrance Germany Italy whereas the UK some Northern countries and AIFMs reluctantlyagreed to it and only after some of its most controversial provisions were watered down(see Buckley and Howarth 2010 Quaglia 2011 Woll 2012) After intense lobbying fromindustry the US and the UK the draft directive was partly revised during the Swedishpresidency2 of the EU in the second semester of 2009 An agreement between the Coun-cil of Ministers and the EP was eventually reached in late October 2010 and the direc-tive is due to enter into force in 2013

It introduces a legally binding authorisation and supervisory regime for all AIFMs inthe EU irrespective of the legal domicile of the alternative investment funds managedHence AIFMs will be subject to authorisation from the competent authority of the homemember state and to reporting requirements of systemically important data to supervisorsThe directive sets up a European passport for AIFMs Hence an AIFM authorised in itshome member state will be entitled to market its funds to professional investors in othermember states which will not be permitted to impose additional requirements (Councilof Ministers and European Parliament 2011)

European Market Infrastructure Regulation

Prior to the global financial crisis a large number of derivatives were traded over thecounter (OTC) not through stock exchanges and were not cleared through central

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counterparties (CCPs) Derivative trading on stock exchanges increases transparency andcentral counterparties reduce counterparty risk (ie the risk of default by one party to thecontract) so that the default of one market participant would not cause the collapse ofother market players thereby putting the entire financial system at risk The OTC deriva-tives comprise a wide variety of products (interest rates credit equity foreign exchangeand commodities) with different characteristics They are used in a variety of waysincluding for purposes of hedging investing and speculating OTC derivatives accountfor almost 90 of the derivatives markets The default of Lehman Brothers and thebailout of AIG highlighted the need to get more reliable information on what goes on inthe OTC derivatives market which in the past had remained outside the perimeter of reg-ulation In the past the US and the UK authorities had adamantly opposed regulatingderivatives They no longer did so after the crisis (on the EU-US regulatory relationsafter the crisis see Pagliari 2012)

In September 2010 the Commission proposed the European Market InfrastructureRegulation (EMIR (Commission 2010d)) The proposed legislation aimed to ensure thetransparency of OTC derivatives transactions and to reduce the risks associated with theseproducts by shifting where possible OTC derivatives trading to CCPs These CCPs wouldreduce counterparty risks because they act as intermediaries between sellers and buyersof derivative products They would ensure the solvency of their participants by requestingdeposits and margin calls The proposed regulation also would involve the creation ofharmonised rules for CCPs and EU supervision of trade repositories The reporting of alltransactions would be mandatory and would provide supervisory authorities with the fullpicture of these markets

EMIR was considered a critical piece of legislation by the Commission and Mem-ber States in order to meet G20 commitments at the September 2009 Pittsburgh sum-mit It was initially conceived by the Commission as a directive but it quicklychanged to become a regulation This distinction is important because as explainedabove regulations are enacted into law with immediate effect in EU member stateswith no discretion over their interpretation EMIR was driven by the Commission withsupport from Germany and France The British government was broadly in favour butopposed certain elements of the proposed legislation (see Buckley et al 2012) TheParliament and the Council agreed on their negotiating positions in July 2011 andOctober 2011 respectively Subsequently a trialogue between the Council the Parlia-ment and the Commission took place The final (Level 1) text of the regulation wasfinally agreed in March 2012 In 2012 the ESMA began drafting Level 2 rules thatsupport the Level 1 regulation

Financial supervision in the EU

The global financial crisis revealed the weaknesses of existing macro-prudential oversightin the EU and the inadequacy of nationally-based supervisory models in overseeing inte-grated financial markets with cross-border operators (Group of Thirty 2009) It exposedshortcomings in the consistent application of Community law (the lack of a Europeanrule book) as well as insufficient cooperation between supervisors in exchanging infor-mation and in crisis management In 2009 a group of high level practitioners and finan-cial experts chaired by the former governor of the Banque de France produced a reporton the issue which was named after the chair of the group (de Larosiegravere Group 2009)Building on the de Larosierersquos report in September 2009 the Commission put forward a

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series of legislative proposals for the reform of the micro- and macro-prudential frame-work for financial supervision in the EU The Commission proposals were eventuallyagreed by the Council and European Parliament in the autumn of 2010 and were imple-mented in early 20113

The main institutional innovations were the establishment of the European SystemicRisk Board its chair to be elected by and from the members of the General Council ofthe European Central Bank (ECB) and in charge of monitoring macro-prudential risk thetransformation of the so-called level three Lamfalussy committees of national regulatorsinto independent authorities with legal personality an increased budget and enhancedpowers The newly created bodies namely the European Banking Authority the Euro-pean Insurance and Occupational Pension Authority and the European Securities MarketsAuthority were charged with the tasks of coordinating the application of supervisorystandards and promoting stronger cooperation between national supervisors Moreoverindividual ESAs were given specific roles for example ESMA is the EU supervisor ofcredit rating agencies while EBA and EIOPA carry out lsquostress testsrsquo of their respectivesectors Yet the new agencies have limited competences and their effective ability toregulate the financial sector remains to be seen

In the negotiations of these institutional reforms disagreements broke out in the Coun-cil and between the Council and the EP concerning the powers of the newly createdbodies as well as the role of the EP in the proposed architecture In the Council therewere (mainly British) concerns about giving the new authorities powers over national reg-ulators and the possibility of supervising individual financial cross-border institutions(Buckley and Howarth 2010) Besides the UK Ireland and Luxemburg were also reluctantto transfer powers away from national supervisors to bodies outside their borders More-over the UK government was reluctant to grant decision-making powers to EU-levelbodies while public funds to tackle banking crises came from national budgets To thiseffect Gordon Brown the British Prime Minister secured a guarantee that the new super-visory system would not include powers to force national governments to bail out banksThat said a number of Member States particularly those with large financial centresnamely the UK France and Germany favoured the limited reform approach and were hes-itant about transferring substantive power to the EU level (Buckley and Howarth 2010)This led to a significant reduction in the scope of the Commission proposals during thenegotiations in the Council By contrast the EP argued that the Commissionrsquos proposalsdid not go far enough and was adamant about safeguarding the powers of the ESAs andenhancing its own oversight role To some extent it was successful in doing so

The Banking Union

The belated banking crisis in Spain (see Royo forthcoming) which risked wreaking thepublic finance in this country exposed the vicious circle between the sovereign debt cri-sis and the financial (meaning banking) crisis In June 2012 the European Council andEuro Area summit agreed to deepen Economic and Monetary Union creating a lsquoBankingUnionrsquo (Euroarea statement 2012) This Union was to be based on four components asingle rulebook more integrated banking supervision a pan-EU deposit guaranteescheme a common EU-wide framework for the managed resolution of banks and finan-cial institutions The Member States decided to make the set-up of a single supervisorymechanism a precondition for the possible direct recapitalisation of banks by the Euro-pean Stability Mechanism (ESM) created to deal with the sovereign debt crisis

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In September 2012 the Commission adopted a set of legislative proposals on theestablishment of a single supervisory mechanism led by the ECB The proposals con-cerned a regulation giving strong powers for the supervision of all banks in the euro areato the ECB and national supervisory authorities a regulation with limited specificchanges to the regulation setting up the European Banking Authority (EBA) to ensure abalance in its decision making structures between the euro area and non-euro area Mem-ber States a communication on a roadmap for completing the banking union over thecoming years covering the single rulebook common deposit protection and a single bankresolution mechanism4

In the new single mechanism ultimate responsibility for specific supervisory tasksrelated to the financial stability of all Euro area banks will lie with the ECB Nationalsupervisors will continue to play an important role in day-to-day supervision and in pre-paring and implementing ECB decisions The ECB will become responsible for taskssuch as authorising credit institutions compliance with capital leverage and liquidityrequirements and conducting supervision of financial conglomerates (Commission of theEuropean Communities 2012a) The ECB will be able to carry out early interventionmeasures when a bank breaches or risks breaching regulatory capital requirements byrequiring banks to take remedial action The Commission also proposed the developmentof the Single Supervisory Handbook by the European Banking Authority (EBA)

The ECB will cooperate with the EBA within the framework of the European Systemof financial supervision The role of the EBA will be similar to today it will continuedeveloping the single rulebook applicable to all 27 Member States and make sure thatsupervisory practices are consistent across the whole Union5 After agreement on thepending proposals as a next step the Commission envisages making a proposal for a sin-gle European resolution mechanism The political discussions on this reform are stillongoing

3 An overall assessment of the reforms in the EU and the main open issues

Three main features of the regulatory measures adopted or officially proposed by the EUin the wake of the crisis stand out First the reforms enacted either regulated activities orfinancial institutions that were previously unregulated in the EU and its member states(CRAs) or at the EU level (AIFMs) or at the national EU and international level(OTCDs) In other instances they imposed heavier more prescriptive and more burden-some requirements on financial entities that were already regulated prior to the crisis asin the case of higher capital requirements for banks and new liquidity management rules(Basel III) or they set in place more substantial protection for depositors (the DGSD)That said some key controversial issues discussed below were not fully addressed

Second although with some notable exceptions the new or amended rules were gen-erally resisted by the UK Ireland Luxemburg and a variable mix of Nordic countriesThe market players primarily affected by the new or revised rules such as CRAs andAIFMs initially resisted the proposed rules Subsequently they engaged in intense lobby-ing with a view to having the proposed rules amended on the grounds that they would beover-prescriptive and costly to implement creating potential regulatory arbitrage vis-agrave-viscountries outside the EU (Quaglia 2012) A somewhat special case was the new capitaland liquidity rules whereby the UK favoured new strict rules on capital requirementsand liquidity provisions whereas France Germany and Italy called for lsquosofterrsquo rules anda longer transition period

Journal of Economic Policy Reform 25

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Third the pace of reform was somewhat piecemeal in the EU This has partly to dowith the interlocking mechanisms of policy making in the EU where there are severalveto players The main agenda-setter of the reform efforts was the Commission which isthe only body that can officially propose legislation in the EU Of course the Commis-sion did so after consulting the member states informally and after holding open publicconsultations In certain cases the Commission was spurred to act by the initiatives ofthe EP as in the case of CRAs and by the continental member states as in the case ofAIFM The Council and the EP were the main decision-makers because they had thepower to adopt or amend the legislation proposed by the Commission Often the memberstates had different priorities and they were worried about potential regulatory arbitragewith jurisdictions outside the EU Lobbying from the financial industry which was keento limit the extent of regulatory change at the national EU and international levels insome cases watered down the proposed reforms but so did the political disagreementbetween the member states

Several problematic issues were highlighted by the crisis and they were only partiallyaddressed by the reforms implemented by the EU afterward The first is the disjuncturebetween globalised financial markets financial market integration in the EU EU financialregulation and national systems of supervision A vast body of international politicaleconomy literature has discussed the internationalisation or globalisation of finance fromthe 1990s onwards (see Helleiner 1994) Financial market integration in the EU substan-tially intensified after the introduction of the single currency and the completion of thesingle market in financial services envisaged by the Financial Services Action Plan in1999 EU rules to a large extent provide the framework for financial regulation in themember states However EU rules are also embedded into or coexist with internationalrules on certain activities The most notable examples are capital requirements for banksset by the Basel accords Unlike financial regulation which is mostly set at the EU levelfinancial supervision in the EU is mainly carried out at the national level by central banks(whenever they are responsible for banking supervision) or the banking supervisoryauthorities if separated from the central bank and the supervisors of other financial activ-ities (eg securities markets)

This fragmentation of powers and responsibilities severely constrains the publicauthoritiesrsquo ability to supervise financial markets and financial entities active in theirjurisdictions This is particularly problematic in the case of ailing cross-border financialinstitutions whereby the key issue is burden sharing that isrsquo the distribution of costsbetween the home and host countries and across the host jurisdictions in which cross-bor-der financial institutions operate (see Dyson and Quaglia 2010) Furthermore sometimesfinancial institutions are too big to be rescued by their home countries ultimately by thetreasury and taxpayers of the country in which they are headquartered This was the caseof the Icelandic banks operating cross-border in the EU This is a challenge not only forthe small countries but also for the large ones that are home countries of very big finan-cial entities For example the Deutsche Bank balance sheet amount to a significant shareof German GDP

Moreover the banking system of several central and eastern European countries is lar-gely foreign owned This raises three main concerns First there are banks that are ofsystemic importance in the new member states but not in the country in which they areheadquartered Second host supervisors can exert only limited control on foreign banksoperating in their jurisdictions particularly when they take the legal form of branchesThis point was stressed in the Turner report 2010 (Financial Services Authority 2009)which went as far as suggesting the compulsory transformation of branches into

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subsidiaries under specific circumstances In the case of subsidiaries which are separatelegal entities in the countries in which they operate key functions might well be centra-lised within the financial groups of which such subsidiaries are part de facto limiting thepower of the host country supervisors Thirdly there is the risk that as a consequence ofthe financial turmoil such banks might retreat (ie pull out funding) abruptly from thehost countries

The bank resolution regime proposed by the Commission in June 2012 after years ofpreparation and several rounds of public consultations does not fully address these short-comings Nor does the DGS directive Ultimately there is an inescapable link betweenfinancial supervision crisis management and resolution and fiscal power (that is theability to use taxpayer money to deal with ailing banks) Fiscal policy goes to the core ofnational sovereignty which explains the reluctance of member states to the creation ofpan-European institutions (be they DGS funds resolution funds or resolution authorities)in this field Moreover the costs and the benefits ensuing from the establishment of theseinstitutions are likely to be unequally distributed across the member states In the endcountries with sound banking systems will have to foot the bill of crisis resolution incountries with less stable banking systems All this raises the problem of the under provi-sion of the public good of financial stability meaning that everybody benefits from finan-cial stability but the costs of providing this public good tend to be specific

Second the global financial crisis brought into sharp relief the interconnection betweenmonetary policy macroeconomic imbalances and financial stability in particular theeffects that the former can have on the latter (see Aktas and Cortuk 2012) Several authorshave pointed out the effects of macroeconomic imbalances such as the permanent deficitsin the US balance of payments (Pauly 2009) and of relatively accommodating monetarypolicies in the US but also to some extent in the EU (Carmassi et al 2009) in fuelling theglobal financial crisis Moreover deficits in the balance of payments are generally accom-panied by fiscal imbalances in particular in Southern Europe where the sovereign debtcrisis followed the financial crisis In turn the sovereign debt crisis risked turning into abanking crisis showing the interconnection between the two types of crises (for a discus-sion of several interesting country studies see Hardie and Howarth forthcoming)

In some countries such as Ireland it was the financial crisis and ultimately the statersquosrescue of the banking system that substantially worsened the public finances (public defi-cit and debt) triggering the sovereign debt crisis In other countries such as Italy andGreece the sovereign debt crisis had domestic origins it was rooted in a loose fiscal pol-icy while the national banking sector was relatively sound and only marginally affectedby the financial (banking) crisis However once the Greek and Italian state faced defaulttheir banking systems were penalised and the sovereign debt crisis risked turning into abanking crisis The problems experienced by some Spanish banks gave new momentumto the idea of a banking union discussed above highlighting the vicious circle betweenbanks and sovereigns Especially in the case of the sovereign debt crisis some commen-tators have argued that the EU and in particular the European Commission is reactive notproactive For example the Nobel-laureate US economist Paul Krugman pointed outthe need for lsquoa Marshall plan for Europersquo (The Guardian 22 January 2012 see alsoKrugman 2012ab)

Conclusions

This article has examined the regulatory response of the EU to the financial crisis endingwith a concise discussion of the link between the financial crisis and the sovereign debt

Journal of Economic Policy Reform 27

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crisis Set against the benchmarks outlined in the introduction it is possible to concludethat despite the new pieces of legislation adopted by the EU the framework for financialservices regulation and supervision in the EU is not substantially different from the pre-crisis one The main obstacles to more far-reaching reform were political not economic

The EU is generally a slow moving institution and tends to be reactive rather thanproactive It took the Commission more than three years and several rounds of consulta-tion to come forward with a formal legislative proposal for a banking resolution regimeNegotiations in the Council and EP have just started and are likely to be time consumingThe DGS directive officially proposed by the Commission in 2010 has not yet beenagreed The proposed Banking Union would represent quite a major reform Yet it is farfrom being agreed and political discussions are ongoing

The Commission is also trying to grapple with structural issues concerning the bank-ing sector in the EU In February 2012 it appointed a High-level Expert Group headedby Erkki Liikanen (former governor of the central bank of Finland) to examine structuralreforms that would directly affect the structure of individual banks and the market as awhole (High Level Expert Group 2012)6 Such reforms could for example includeprohibiting banks from carrying out some activities such as proprietary trading (asenvisaged in the Dodd-Frank act in the US) or requiring banks to ring-fence theirdeposit-taking activities from investment banking as proposed by the IndependentBanking Commission in the UK In this case as well the jury is still out

AcknowledgementsThe author wishes to acknowledge financial support from the European Research Council (204398FINGOVEU) and the British Academy (SG 120191) This paper was written while the author wasa visiting fellow at the Max Planck Institute the European University Institute and HanseWissenschaftskolleg

Notes1 httpeuropaeurapidpressReleasesActiondoreference=MEMO12416ampfor-

mat=HTMLampaged=0amplanguage=ENampguiLanguage=en2 Sweden has a significant private equity industry hence it was seen as having a vested interest

in the revision of the text of the directive3 All these legislative texts can be found at httpeceuropaeuinternal_marketfinancescommit-

teesindex_enhtm4 httpeuropaeurapidpress-release_MEMO-12-656_enhtmlocale=en5 httpeuropaeurapidpress-release_IP-12-953_enhtmlocale=en6 httpeuropaeurapidpressReleasesActiondoreference=MEMO12129ampfor-

mat=HTMLampaged=1amplanguage=ENampguiLanguage=en]

ReferencesAktas C and Cortuk O 2012 Turkeyrsquos experience with the global crisis restructuring policies

within a financial stability framework Journal of Economic Policy Reform 15 (3) 195ndash205Baker A 2012 The new political economy of the macroprudential ideational shift New Political

Economy iFirstBasel Committee on Banking Supervision 2010a Basel III A global regulatory framework for

more resilient banks and banking systems DecemberBasel Committee on Banking Supervision 2010b Basel III International framework for liquidity

risk measurement standards and monitoring DecemberBroby D 2012 The regulatory evolution of the post credit crisis fund management industry

Journal of Economic Policy Reform 15 (1) 5ndash11Brunnermeier M Crockett A Goodhart C Persaud AD Shin HS 2009 The fundamental

principles of financial regulation Geneva Reports on the World Economy 11

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integrated European financial market An EU mechanism to deal with cross-border ailingbanks was needed Third the crisis underscored the importance of macroprudential super-vision in the EU as well as in other jurisdictions (eg the US) (on the spread of macro-economic ideas see Baker 2012) Financial supervision was to be reformed in light ofthis

The article argues that financial regulation and supervision in the EU after the crisisare still poorly equipped to deal with (or to prevent) future financial crises mainlybecause of the political constraints (of various kinds) encountered during the reform pro-cess One of the most important lessons to be drawn from this case study is that politicalfactors are as important as (if not more important than) economic factors in shaping theframework for financial services regulation and supervision in the EU (and elsewhere)

2 The reform of financial regulation and supervision in the EU

A host of new regulatory initiatives were undertaken by the EU in the aftermath of theglobal financial crisis besides the short-term crisis management measures adopted in themidst of the turmoil (Quaglia et al 2009) The new rules introduced or substantiallyamended mainly concerned banking securities markets and financial supervision eventhough certain legislative measures cannot easily been pigeonholed in one of these cate-gories The EUrsquos actions that have not resulted in lsquohardrsquo legislative measures such as theRecommendation on Remuneration Policies (Commission of the European Communities2009) are not examined here because they are not legally binding

Banking regulation in the EU

Directives on Deposit and Investor guarantee schemes

As far as banking is concerned the global financial crisis brought into the spotlight theinadequacy of the existing Deposit Guarantee Scheme (DGS) directive dating back to1994 This directive set the minimum level of deposit protection schemes in the EU toe20000 per depositor When the crisis broke out the depositor protection coverage ran-ged from e20000 in the new member states and the UK to more than e100000 in Italyand France Moreover uncoordinated decisions on deposit guarantees taken by somemember states worsened the crisis

At the peak of the crisis the Commission proposed legislative changes concerning theDGS directive These changes which were agreed in a rush in 2009 represented anemergency measure designed to restore depositorsrsquo confidence by raising the minimumlevel of coverage for deposits from e20000 to e50000 and subsequently to e100000The need for swift action meant that several open issues were not tackled and hence thedirective contained a clause providing for a broad review of all aspects of DGSs

In July 2010 the Commission put forward a legislative proposal on DGS for bankswith a view to addressing the remaining issues (Commission 2010a) The proposed direc-tive contained measures for the harmonisation of coverage and the simplification ofarrangements for payout One of the most contentious provisions was the establishmentof a mandatory mutual borrowing facility whereby if a national deposit guarantee schemeis depleted it can borrow from another national fund Several member states tried to takethis provision out while discussing this piece of legislation in the Council The mutualborrowing facility could be the first step towards a pan-EU deposit guarantee schemewhich was even more controversial Indeed in the preparation of the directive the

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Commission considered the setting up of a single pan-European scheme However itsoon realised that there were complicated legal issues that needed to be examined andtherefore the idea of a pan-European DGS was temporarily shelved Ultimately howeverthe problem was political The creation of a pan-European DGS would have impliedpooling national sovereignty to an extent not acceptable to the ember states as explainedin Section 3 A report examining this issue will be presented by the Commission by2014 (Commission 2010a)

The directive on DGS for banks was part of a package on guarantee schemes in thefinancial sector which also comprised a review of investor compensation schemes (Com-mission 2010b) and a White Paper on insurance guarantee schemes (Commission 2010c)all issued in July 2010 The Investor Compensation Scheme directive dating back to1997 established a minimum level of compensation in cases where an investment firmwas unable to return assets belonging to an investor The Commissionrsquos proposal for arevision of this directive raised the minimum level of compensation for investors frome20000 to e50000 per investor The payout time was reduced to up to 9 months Theapproval of these pieces of legislation is pending

Capital requirements for banks and investment firms

Capital requirements for banks have traditionally been regarded as one of the main instru-ments to ensure the stability of the banking sector and hence financial stability tout courtIn 1988 the Basel Committee on Banking Supervision (BCBS) issued the Basel I Accordon lsquoInternational convergence of capital measurement and capital standardsrsquo which wasupdated by the Basel II Accord in 2004 Over time these lsquosoftrsquo international rules havebeen incorporated into (legally binding) national legislation in more than 100 countriesIn the EU this has been done through the capital requirements directives (CRD)

Various revisions of the CRD were carried out in parallel with the international debateon this issue taking place in the BCBS when the crisis broke out The revisions of theCRD in 2009 and 2010 set higher capital requirements on the trading book and re-securi-tisations imposed stronger disclosure requirements for securitisation exposures andrequired banks to have sound remuneration practices that did not encourage or rewardexcessive risk-taking The scope of these changes however remained quite limitedbecause a comprehensive revision of the Basel II accord was pending

The Basel III accord was signed by the BCBS in December 2010 (Basel Committeeon Banking Supervision 2010ab) The new rules provide a more restrictive definition ofwhat counts as capital increase the risk weight of several assets in the banking book andintroduce capital buffers set up a recommended and potentially obligatory leverage ratioand outline international rules on liquidity management All in all the new rules increasethe proportion of capital that must be of proven loss absorbing capacity (going concern)ie core tier one (equity) capital over Basel II requirements and will be phased in gradu-ally from January 2013 until 2019

Once the Basel III accord was agreed internationally the process of incorporating itinto EU legislation began in earnest In July 2011 after extensive consultation conductedin parallel with the work of the BCBS the EU Commission adopted the CRDIV legisla-tive package designed to replace the CRDIII with a directive that governs the access todeposit-taking activities (Commission 2011a) and a regulation that establishes prudentialrequirements for credit institutions (Commission 2011b) After its approval the proposeddirective (Commission 2011a) will have to be transposed by the member states in a waysuitable to their own national environment It contains rules concerning the taking up and

Journal of Economic Policy Reform 19

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pursuit of the business of banks the conditions for the freedom of establishment and thefreedom to provide services the supervisory review process and the definition of compe-tent authorities The directive also incorporates two elements of the Basel III accordnamely the introduction of two capital buffers on top of the minimum capital require-ments the capital conservation buffer identical for all banks in the EU and the countercy-clical capital buffer to be determined at national level The proposed EU regulation(CRR) (Commission 2011b) contains prudential requirements for credit institutions andinvestment firms The proposed regulation covers the definition of capital increasing theamount of own funds that banks need to hold as well as the quality of those funds itintroduces the Liquidity Coverage Ratio ndash the exact composition and calibration of whichwill be determined after an observation and review period in 2015 and the need to con-sider a leverage ratio subject to supervisory review

The Commissionrsquos CRDIV draft was criticised for watering down or modifying theBasel III guidelines in ways to meet EU member state demands (International MonetaryFund 2011) The Commission lsquosoftenedrsquo its definition of Core Tier I capital relative tothe Basel III recommendations in some areas For example it allowed lsquosilent participa-tionsrsquo that is state loans that make up a significant part of public Landesbanken capitalin Germany The Commissionrsquos draft limited the role of the leverage ratio designed tolimit risk-taking at banks On liquidity the Commissionrsquos draft adopted a less prescriptivedefinition of liquid assets and lacks a firm commitment to implement the Net StableFunding Ratio The proposed regulation also sets higher capital requirements for Overthe Counter (OTC) derivatives that are not cleared through Central Counterparties

The use of a regulation which once approved is directly applicable without the needfor national transposition was designed to ensure the creation of a single rule book inthe EU The regulation eliminates a key source of national divergence In the CRD IImore than 100 national discretions (differences in national legislation transposing the EUdirective) remained The Commission also proposed a maximum capital ratio that wasopposed by those such as UK policy-makers who argued in favour of EU standards thatexceed the Basel minimum Indeed in the negotiations of the new capital requirements inBasel and Brussels British policy-makers favoured strict rules on capital and liquidityBy contrast French and German policy-makers supported lsquosofterrsquo rules These memberstates the European Parliament (EP) and the Commission called for taking into accountlsquoEuropean specificitiesrsquo in incorporating the Basel III rules into the CRD IV reopeningsome of the issues that had caused friction within the BCBS Indeed the ongoing negoti-ations of this legislation are slowed down by different national preferences across themember state which in turn are due to the likely effects of the new rules in the memberstates (Howarth and Quaglia forthcoming)

Directive establishing the framework for the recovery and resolution of credit institutionsand investment firms

During the financial crisis several large banks were bailed out with public funds becausethey were considered lsquotoo big to failrsquo In June 2012 the Commission adopted a legislativeproposal for bank recovery and resolution (Commission 2012b) designed to avoid govern-ment bailout of large banks in the future The scope of application of the proposal was thesame as the CRD discussed above hence it applied to all credit institutions and certaininvestment firms The proposal distinguished between powers of lsquopreventionrsquo lsquoearly inter-ventionrsquo and lsquoresolutionrsquo In the case of prevention banks are required to draw up recoveryplans and resolution authorities are required to prepare resolution plans both at group level

20 L Quaglia

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and for the individual institutions within the group Authorities can require a bank tochange its legal or operational structures to ensure that it can be resolved with the availabletools Financial groups may enter into intra-group support agreements in the form of loansor the provision of guarantees The framework envisages early supervisory interventionwhereby the authorities could require banks to implement measures set out in the recoveryplan and would have the power to appoint a special manager at a bank for a limited period

The harmonised resolution tools and powers outlined in the directive are designed toensure that national authorities in all member states have a common toolkit and roadmapto manage the failure of banks Amongst the tools considered there is the bail-in toolwhereby banks would be recapitalised with shareholders wiped out or diluted and credi-tors would have their claims reduced or converted to shares Resolution colleges are tobe established under the leadership of the group resolution authority and with the partici-pation of the European Banking Authority (EBA) The EBA will facilitate joint actionsand act as a binding mediator if necessary

The legislation envisaged the creation of resolution funding which would raise contri-butions from banks proportionate to their liabilities and risk profiles and would not beused to bail out a bank There is a link between this piece of legislation and the directiveon DGS which will provide funding for the protection of retail depositors Member stateswill be allowed to merge these two funds provided that the scheme remains in positionto repay depositors in case of failure The Commission noted that ideally a single pan-European fund should be established with a pan-European resolution authority to manageits disbursal but the absence of a single European banking supervisor and insolvencyregime would make this unworkable1 As in the case of the DGS the obstacles to thesefar-reaching changes were ultimately political as explained in Section 3 and negotiationsare ongoing

Securities markets regulation in the EU

Regulation on Credit Rating Agencies

In the securities sector Credit Rating Agencies (CRAs) were singled out amongst the mainculprits of the crisis for failing to rate properly financial products (Brunnermeier et al2009) They substantially over-rated many complex securities created through the financialactivity of securitisation and were slow in revising their ratings once market conditionsdeteriorated The over-generous rating of securities was influenced by the strong competi-tion taking place between CRAs in order to attract clients and by conflicts of interestbecause CRAs provided a variety of other services to the potential issuers requiring ratinghence they had strong incentives to be generous in their assessment of creditworthiness

Prior to the crisis CRAs were regulated internationally by a voluntary Code of Con-duct Fundamentals issued by IOSCO in 2004 and revised in the wake of the crisis in2008 The EU had considered and then ruled out specific EU rules on CRAs (Muumlgge2011) After the crisis the French presidency of the EU in the second semester of 2008implicitly made EU legislation on CRAs one of its priorities The European Council calledfor a legislative proposal to strengthen the rules on credit rating agencies and their supervi-sion at EU level in October 2008 (Quaglia 2009) Influential MEPs supported the regula-tion of CRAs in the EU The (revised) IOSCO Code provided the benchmark for theCommissionrsquos draft regulation on CRAs However the Commission argued that theIOSCO rules needed to be made more concrete and be backed by enforcement (Moschella2011 Pagliari 2011)

Journal of Economic Policy Reform 21

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The Regulation on CRAs was agreed relatively quickly by the EU in less than a yearAccording to the new rules all CRAs whose ratings are used in the EU need to applyfor registration in the EU and have to comply with rules designed to prevent conflict ofinterest in the rating process and to ensure the quality of the rating methodology and theratings CRAs operating in non-EU jurisdictions can issue ratings to be used in the EUprovided that their countries of origin have a regulatory framework recognised as equiva-lent to the one put in place by the EU or that such ratings are endorsed by an EU-regis-tered CRA (Council of Ministers and European Parliament 2009)

In June 2010 the Commission proposed an amendment of the Regulation on CRAsadopted in 2009 Since ratings issued by a CRA can be used by financial institutionsthroughout the EU the Commission proposed a more centralised system for supervisionof CRAs whereby the newly created European Securities and Markets Authority (ESMAdiscussed below) was entrusted with exclusive supervisory powers over CRAs registeredin the EU including European subsidiaries of US-headquartered CRAs such as FitchMoody and Standard amp Poor The ESMA was given powers to request information tolaunch investigations and to perform on-site inspections The amended regulation wasadopted by the Council and the EP in May 2011 (Council of Ministers and European Par-liament 2011) In the summer of 2011 the downgrading of the government bonds in thecountries directly hit by the sovereign debt crisis by the (mainly US-headquartered)CRAs gave new momentum to the debate on the creation of the European rating agencya proposal that was put forward by the EP

Alternative Investment Funds Managers Directive

The attempt to regulate hedge funds in the EU was given new momentum by the finan-cial crisis (see Broby 2012) In June 2009 the European Commission presented its pro-posal for the draft directive on AIFMs (Alternative Investment Funds Managers) whichincluded managers of hedge funds private equities funds and real estate funds hencecovering quite a broad range of financial entities The main sponsors of the directive wereFrance Germany Italy whereas the UK some Northern countries and AIFMs reluctantlyagreed to it and only after some of its most controversial provisions were watered down(see Buckley and Howarth 2010 Quaglia 2011 Woll 2012) After intense lobbying fromindustry the US and the UK the draft directive was partly revised during the Swedishpresidency2 of the EU in the second semester of 2009 An agreement between the Coun-cil of Ministers and the EP was eventually reached in late October 2010 and the direc-tive is due to enter into force in 2013

It introduces a legally binding authorisation and supervisory regime for all AIFMs inthe EU irrespective of the legal domicile of the alternative investment funds managedHence AIFMs will be subject to authorisation from the competent authority of the homemember state and to reporting requirements of systemically important data to supervisorsThe directive sets up a European passport for AIFMs Hence an AIFM authorised in itshome member state will be entitled to market its funds to professional investors in othermember states which will not be permitted to impose additional requirements (Councilof Ministers and European Parliament 2011)

European Market Infrastructure Regulation

Prior to the global financial crisis a large number of derivatives were traded over thecounter (OTC) not through stock exchanges and were not cleared through central

22 L Quaglia

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counterparties (CCPs) Derivative trading on stock exchanges increases transparency andcentral counterparties reduce counterparty risk (ie the risk of default by one party to thecontract) so that the default of one market participant would not cause the collapse ofother market players thereby putting the entire financial system at risk The OTC deriva-tives comprise a wide variety of products (interest rates credit equity foreign exchangeand commodities) with different characteristics They are used in a variety of waysincluding for purposes of hedging investing and speculating OTC derivatives accountfor almost 90 of the derivatives markets The default of Lehman Brothers and thebailout of AIG highlighted the need to get more reliable information on what goes on inthe OTC derivatives market which in the past had remained outside the perimeter of reg-ulation In the past the US and the UK authorities had adamantly opposed regulatingderivatives They no longer did so after the crisis (on the EU-US regulatory relationsafter the crisis see Pagliari 2012)

In September 2010 the Commission proposed the European Market InfrastructureRegulation (EMIR (Commission 2010d)) The proposed legislation aimed to ensure thetransparency of OTC derivatives transactions and to reduce the risks associated with theseproducts by shifting where possible OTC derivatives trading to CCPs These CCPs wouldreduce counterparty risks because they act as intermediaries between sellers and buyersof derivative products They would ensure the solvency of their participants by requestingdeposits and margin calls The proposed regulation also would involve the creation ofharmonised rules for CCPs and EU supervision of trade repositories The reporting of alltransactions would be mandatory and would provide supervisory authorities with the fullpicture of these markets

EMIR was considered a critical piece of legislation by the Commission and Mem-ber States in order to meet G20 commitments at the September 2009 Pittsburgh sum-mit It was initially conceived by the Commission as a directive but it quicklychanged to become a regulation This distinction is important because as explainedabove regulations are enacted into law with immediate effect in EU member stateswith no discretion over their interpretation EMIR was driven by the Commission withsupport from Germany and France The British government was broadly in favour butopposed certain elements of the proposed legislation (see Buckley et al 2012) TheParliament and the Council agreed on their negotiating positions in July 2011 andOctober 2011 respectively Subsequently a trialogue between the Council the Parlia-ment and the Commission took place The final (Level 1) text of the regulation wasfinally agreed in March 2012 In 2012 the ESMA began drafting Level 2 rules thatsupport the Level 1 regulation

Financial supervision in the EU

The global financial crisis revealed the weaknesses of existing macro-prudential oversightin the EU and the inadequacy of nationally-based supervisory models in overseeing inte-grated financial markets with cross-border operators (Group of Thirty 2009) It exposedshortcomings in the consistent application of Community law (the lack of a Europeanrule book) as well as insufficient cooperation between supervisors in exchanging infor-mation and in crisis management In 2009 a group of high level practitioners and finan-cial experts chaired by the former governor of the Banque de France produced a reporton the issue which was named after the chair of the group (de Larosiegravere Group 2009)Building on the de Larosierersquos report in September 2009 the Commission put forward a

Journal of Economic Policy Reform 23

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series of legislative proposals for the reform of the micro- and macro-prudential frame-work for financial supervision in the EU The Commission proposals were eventuallyagreed by the Council and European Parliament in the autumn of 2010 and were imple-mented in early 20113

The main institutional innovations were the establishment of the European SystemicRisk Board its chair to be elected by and from the members of the General Council ofthe European Central Bank (ECB) and in charge of monitoring macro-prudential risk thetransformation of the so-called level three Lamfalussy committees of national regulatorsinto independent authorities with legal personality an increased budget and enhancedpowers The newly created bodies namely the European Banking Authority the Euro-pean Insurance and Occupational Pension Authority and the European Securities MarketsAuthority were charged with the tasks of coordinating the application of supervisorystandards and promoting stronger cooperation between national supervisors Moreoverindividual ESAs were given specific roles for example ESMA is the EU supervisor ofcredit rating agencies while EBA and EIOPA carry out lsquostress testsrsquo of their respectivesectors Yet the new agencies have limited competences and their effective ability toregulate the financial sector remains to be seen

In the negotiations of these institutional reforms disagreements broke out in the Coun-cil and between the Council and the EP concerning the powers of the newly createdbodies as well as the role of the EP in the proposed architecture In the Council therewere (mainly British) concerns about giving the new authorities powers over national reg-ulators and the possibility of supervising individual financial cross-border institutions(Buckley and Howarth 2010) Besides the UK Ireland and Luxemburg were also reluctantto transfer powers away from national supervisors to bodies outside their borders More-over the UK government was reluctant to grant decision-making powers to EU-levelbodies while public funds to tackle banking crises came from national budgets To thiseffect Gordon Brown the British Prime Minister secured a guarantee that the new super-visory system would not include powers to force national governments to bail out banksThat said a number of Member States particularly those with large financial centresnamely the UK France and Germany favoured the limited reform approach and were hes-itant about transferring substantive power to the EU level (Buckley and Howarth 2010)This led to a significant reduction in the scope of the Commission proposals during thenegotiations in the Council By contrast the EP argued that the Commissionrsquos proposalsdid not go far enough and was adamant about safeguarding the powers of the ESAs andenhancing its own oversight role To some extent it was successful in doing so

The Banking Union

The belated banking crisis in Spain (see Royo forthcoming) which risked wreaking thepublic finance in this country exposed the vicious circle between the sovereign debt cri-sis and the financial (meaning banking) crisis In June 2012 the European Council andEuro Area summit agreed to deepen Economic and Monetary Union creating a lsquoBankingUnionrsquo (Euroarea statement 2012) This Union was to be based on four components asingle rulebook more integrated banking supervision a pan-EU deposit guaranteescheme a common EU-wide framework for the managed resolution of banks and finan-cial institutions The Member States decided to make the set-up of a single supervisorymechanism a precondition for the possible direct recapitalisation of banks by the Euro-pean Stability Mechanism (ESM) created to deal with the sovereign debt crisis

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In September 2012 the Commission adopted a set of legislative proposals on theestablishment of a single supervisory mechanism led by the ECB The proposals con-cerned a regulation giving strong powers for the supervision of all banks in the euro areato the ECB and national supervisory authorities a regulation with limited specificchanges to the regulation setting up the European Banking Authority (EBA) to ensure abalance in its decision making structures between the euro area and non-euro area Mem-ber States a communication on a roadmap for completing the banking union over thecoming years covering the single rulebook common deposit protection and a single bankresolution mechanism4

In the new single mechanism ultimate responsibility for specific supervisory tasksrelated to the financial stability of all Euro area banks will lie with the ECB Nationalsupervisors will continue to play an important role in day-to-day supervision and in pre-paring and implementing ECB decisions The ECB will become responsible for taskssuch as authorising credit institutions compliance with capital leverage and liquidityrequirements and conducting supervision of financial conglomerates (Commission of theEuropean Communities 2012a) The ECB will be able to carry out early interventionmeasures when a bank breaches or risks breaching regulatory capital requirements byrequiring banks to take remedial action The Commission also proposed the developmentof the Single Supervisory Handbook by the European Banking Authority (EBA)

The ECB will cooperate with the EBA within the framework of the European Systemof financial supervision The role of the EBA will be similar to today it will continuedeveloping the single rulebook applicable to all 27 Member States and make sure thatsupervisory practices are consistent across the whole Union5 After agreement on thepending proposals as a next step the Commission envisages making a proposal for a sin-gle European resolution mechanism The political discussions on this reform are stillongoing

3 An overall assessment of the reforms in the EU and the main open issues

Three main features of the regulatory measures adopted or officially proposed by the EUin the wake of the crisis stand out First the reforms enacted either regulated activities orfinancial institutions that were previously unregulated in the EU and its member states(CRAs) or at the EU level (AIFMs) or at the national EU and international level(OTCDs) In other instances they imposed heavier more prescriptive and more burden-some requirements on financial entities that were already regulated prior to the crisis asin the case of higher capital requirements for banks and new liquidity management rules(Basel III) or they set in place more substantial protection for depositors (the DGSD)That said some key controversial issues discussed below were not fully addressed

Second although with some notable exceptions the new or amended rules were gen-erally resisted by the UK Ireland Luxemburg and a variable mix of Nordic countriesThe market players primarily affected by the new or revised rules such as CRAs andAIFMs initially resisted the proposed rules Subsequently they engaged in intense lobby-ing with a view to having the proposed rules amended on the grounds that they would beover-prescriptive and costly to implement creating potential regulatory arbitrage vis-agrave-viscountries outside the EU (Quaglia 2012) A somewhat special case was the new capitaland liquidity rules whereby the UK favoured new strict rules on capital requirementsand liquidity provisions whereas France Germany and Italy called for lsquosofterrsquo rules anda longer transition period

Journal of Economic Policy Reform 25

Dow

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13

Third the pace of reform was somewhat piecemeal in the EU This has partly to dowith the interlocking mechanisms of policy making in the EU where there are severalveto players The main agenda-setter of the reform efforts was the Commission which isthe only body that can officially propose legislation in the EU Of course the Commis-sion did so after consulting the member states informally and after holding open publicconsultations In certain cases the Commission was spurred to act by the initiatives ofthe EP as in the case of CRAs and by the continental member states as in the case ofAIFM The Council and the EP were the main decision-makers because they had thepower to adopt or amend the legislation proposed by the Commission Often the memberstates had different priorities and they were worried about potential regulatory arbitragewith jurisdictions outside the EU Lobbying from the financial industry which was keento limit the extent of regulatory change at the national EU and international levels insome cases watered down the proposed reforms but so did the political disagreementbetween the member states

Several problematic issues were highlighted by the crisis and they were only partiallyaddressed by the reforms implemented by the EU afterward The first is the disjuncturebetween globalised financial markets financial market integration in the EU EU financialregulation and national systems of supervision A vast body of international politicaleconomy literature has discussed the internationalisation or globalisation of finance fromthe 1990s onwards (see Helleiner 1994) Financial market integration in the EU substan-tially intensified after the introduction of the single currency and the completion of thesingle market in financial services envisaged by the Financial Services Action Plan in1999 EU rules to a large extent provide the framework for financial regulation in themember states However EU rules are also embedded into or coexist with internationalrules on certain activities The most notable examples are capital requirements for banksset by the Basel accords Unlike financial regulation which is mostly set at the EU levelfinancial supervision in the EU is mainly carried out at the national level by central banks(whenever they are responsible for banking supervision) or the banking supervisoryauthorities if separated from the central bank and the supervisors of other financial activ-ities (eg securities markets)

This fragmentation of powers and responsibilities severely constrains the publicauthoritiesrsquo ability to supervise financial markets and financial entities active in theirjurisdictions This is particularly problematic in the case of ailing cross-border financialinstitutions whereby the key issue is burden sharing that isrsquo the distribution of costsbetween the home and host countries and across the host jurisdictions in which cross-bor-der financial institutions operate (see Dyson and Quaglia 2010) Furthermore sometimesfinancial institutions are too big to be rescued by their home countries ultimately by thetreasury and taxpayers of the country in which they are headquartered This was the caseof the Icelandic banks operating cross-border in the EU This is a challenge not only forthe small countries but also for the large ones that are home countries of very big finan-cial entities For example the Deutsche Bank balance sheet amount to a significant shareof German GDP

Moreover the banking system of several central and eastern European countries is lar-gely foreign owned This raises three main concerns First there are banks that are ofsystemic importance in the new member states but not in the country in which they areheadquartered Second host supervisors can exert only limited control on foreign banksoperating in their jurisdictions particularly when they take the legal form of branchesThis point was stressed in the Turner report 2010 (Financial Services Authority 2009)which went as far as suggesting the compulsory transformation of branches into

26 L Quaglia

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subsidiaries under specific circumstances In the case of subsidiaries which are separatelegal entities in the countries in which they operate key functions might well be centra-lised within the financial groups of which such subsidiaries are part de facto limiting thepower of the host country supervisors Thirdly there is the risk that as a consequence ofthe financial turmoil such banks might retreat (ie pull out funding) abruptly from thehost countries

The bank resolution regime proposed by the Commission in June 2012 after years ofpreparation and several rounds of public consultations does not fully address these short-comings Nor does the DGS directive Ultimately there is an inescapable link betweenfinancial supervision crisis management and resolution and fiscal power (that is theability to use taxpayer money to deal with ailing banks) Fiscal policy goes to the core ofnational sovereignty which explains the reluctance of member states to the creation ofpan-European institutions (be they DGS funds resolution funds or resolution authorities)in this field Moreover the costs and the benefits ensuing from the establishment of theseinstitutions are likely to be unequally distributed across the member states In the endcountries with sound banking systems will have to foot the bill of crisis resolution incountries with less stable banking systems All this raises the problem of the under provi-sion of the public good of financial stability meaning that everybody benefits from finan-cial stability but the costs of providing this public good tend to be specific

Second the global financial crisis brought into sharp relief the interconnection betweenmonetary policy macroeconomic imbalances and financial stability in particular theeffects that the former can have on the latter (see Aktas and Cortuk 2012) Several authorshave pointed out the effects of macroeconomic imbalances such as the permanent deficitsin the US balance of payments (Pauly 2009) and of relatively accommodating monetarypolicies in the US but also to some extent in the EU (Carmassi et al 2009) in fuelling theglobal financial crisis Moreover deficits in the balance of payments are generally accom-panied by fiscal imbalances in particular in Southern Europe where the sovereign debtcrisis followed the financial crisis In turn the sovereign debt crisis risked turning into abanking crisis showing the interconnection between the two types of crises (for a discus-sion of several interesting country studies see Hardie and Howarth forthcoming)

In some countries such as Ireland it was the financial crisis and ultimately the statersquosrescue of the banking system that substantially worsened the public finances (public defi-cit and debt) triggering the sovereign debt crisis In other countries such as Italy andGreece the sovereign debt crisis had domestic origins it was rooted in a loose fiscal pol-icy while the national banking sector was relatively sound and only marginally affectedby the financial (banking) crisis However once the Greek and Italian state faced defaulttheir banking systems were penalised and the sovereign debt crisis risked turning into abanking crisis The problems experienced by some Spanish banks gave new momentumto the idea of a banking union discussed above highlighting the vicious circle betweenbanks and sovereigns Especially in the case of the sovereign debt crisis some commen-tators have argued that the EU and in particular the European Commission is reactive notproactive For example the Nobel-laureate US economist Paul Krugman pointed outthe need for lsquoa Marshall plan for Europersquo (The Guardian 22 January 2012 see alsoKrugman 2012ab)

Conclusions

This article has examined the regulatory response of the EU to the financial crisis endingwith a concise discussion of the link between the financial crisis and the sovereign debt

Journal of Economic Policy Reform 27

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crisis Set against the benchmarks outlined in the introduction it is possible to concludethat despite the new pieces of legislation adopted by the EU the framework for financialservices regulation and supervision in the EU is not substantially different from the pre-crisis one The main obstacles to more far-reaching reform were political not economic

The EU is generally a slow moving institution and tends to be reactive rather thanproactive It took the Commission more than three years and several rounds of consulta-tion to come forward with a formal legislative proposal for a banking resolution regimeNegotiations in the Council and EP have just started and are likely to be time consumingThe DGS directive officially proposed by the Commission in 2010 has not yet beenagreed The proposed Banking Union would represent quite a major reform Yet it is farfrom being agreed and political discussions are ongoing

The Commission is also trying to grapple with structural issues concerning the bank-ing sector in the EU In February 2012 it appointed a High-level Expert Group headedby Erkki Liikanen (former governor of the central bank of Finland) to examine structuralreforms that would directly affect the structure of individual banks and the market as awhole (High Level Expert Group 2012)6 Such reforms could for example includeprohibiting banks from carrying out some activities such as proprietary trading (asenvisaged in the Dodd-Frank act in the US) or requiring banks to ring-fence theirdeposit-taking activities from investment banking as proposed by the IndependentBanking Commission in the UK In this case as well the jury is still out

AcknowledgementsThe author wishes to acknowledge financial support from the European Research Council (204398FINGOVEU) and the British Academy (SG 120191) This paper was written while the author wasa visiting fellow at the Max Planck Institute the European University Institute and HanseWissenschaftskolleg

Notes1 httpeuropaeurapidpressReleasesActiondoreference=MEMO12416ampfor-

mat=HTMLampaged=0amplanguage=ENampguiLanguage=en2 Sweden has a significant private equity industry hence it was seen as having a vested interest

in the revision of the text of the directive3 All these legislative texts can be found at httpeceuropaeuinternal_marketfinancescommit-

teesindex_enhtm4 httpeuropaeurapidpress-release_MEMO-12-656_enhtmlocale=en5 httpeuropaeurapidpress-release_IP-12-953_enhtmlocale=en6 httpeuropaeurapidpressReleasesActiondoreference=MEMO12129ampfor-

mat=HTMLampaged=1amplanguage=ENampguiLanguage=en]

ReferencesAktas C and Cortuk O 2012 Turkeyrsquos experience with the global crisis restructuring policies

within a financial stability framework Journal of Economic Policy Reform 15 (3) 195ndash205Baker A 2012 The new political economy of the macroprudential ideational shift New Political

Economy iFirstBasel Committee on Banking Supervision 2010a Basel III A global regulatory framework for

more resilient banks and banking systems DecemberBasel Committee on Banking Supervision 2010b Basel III International framework for liquidity

risk measurement standards and monitoring DecemberBroby D 2012 The regulatory evolution of the post credit crisis fund management industry

Journal of Economic Policy Reform 15 (1) 5ndash11Brunnermeier M Crockett A Goodhart C Persaud AD Shin HS 2009 The fundamental

principles of financial regulation Geneva Reports on the World Economy 11

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Commission considered the setting up of a single pan-European scheme However itsoon realised that there were complicated legal issues that needed to be examined andtherefore the idea of a pan-European DGS was temporarily shelved Ultimately howeverthe problem was political The creation of a pan-European DGS would have impliedpooling national sovereignty to an extent not acceptable to the ember states as explainedin Section 3 A report examining this issue will be presented by the Commission by2014 (Commission 2010a)

The directive on DGS for banks was part of a package on guarantee schemes in thefinancial sector which also comprised a review of investor compensation schemes (Com-mission 2010b) and a White Paper on insurance guarantee schemes (Commission 2010c)all issued in July 2010 The Investor Compensation Scheme directive dating back to1997 established a minimum level of compensation in cases where an investment firmwas unable to return assets belonging to an investor The Commissionrsquos proposal for arevision of this directive raised the minimum level of compensation for investors frome20000 to e50000 per investor The payout time was reduced to up to 9 months Theapproval of these pieces of legislation is pending

Capital requirements for banks and investment firms

Capital requirements for banks have traditionally been regarded as one of the main instru-ments to ensure the stability of the banking sector and hence financial stability tout courtIn 1988 the Basel Committee on Banking Supervision (BCBS) issued the Basel I Accordon lsquoInternational convergence of capital measurement and capital standardsrsquo which wasupdated by the Basel II Accord in 2004 Over time these lsquosoftrsquo international rules havebeen incorporated into (legally binding) national legislation in more than 100 countriesIn the EU this has been done through the capital requirements directives (CRD)

Various revisions of the CRD were carried out in parallel with the international debateon this issue taking place in the BCBS when the crisis broke out The revisions of theCRD in 2009 and 2010 set higher capital requirements on the trading book and re-securi-tisations imposed stronger disclosure requirements for securitisation exposures andrequired banks to have sound remuneration practices that did not encourage or rewardexcessive risk-taking The scope of these changes however remained quite limitedbecause a comprehensive revision of the Basel II accord was pending

The Basel III accord was signed by the BCBS in December 2010 (Basel Committeeon Banking Supervision 2010ab) The new rules provide a more restrictive definition ofwhat counts as capital increase the risk weight of several assets in the banking book andintroduce capital buffers set up a recommended and potentially obligatory leverage ratioand outline international rules on liquidity management All in all the new rules increasethe proportion of capital that must be of proven loss absorbing capacity (going concern)ie core tier one (equity) capital over Basel II requirements and will be phased in gradu-ally from January 2013 until 2019

Once the Basel III accord was agreed internationally the process of incorporating itinto EU legislation began in earnest In July 2011 after extensive consultation conductedin parallel with the work of the BCBS the EU Commission adopted the CRDIV legisla-tive package designed to replace the CRDIII with a directive that governs the access todeposit-taking activities (Commission 2011a) and a regulation that establishes prudentialrequirements for credit institutions (Commission 2011b) After its approval the proposeddirective (Commission 2011a) will have to be transposed by the member states in a waysuitable to their own national environment It contains rules concerning the taking up and

Journal of Economic Policy Reform 19

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pursuit of the business of banks the conditions for the freedom of establishment and thefreedom to provide services the supervisory review process and the definition of compe-tent authorities The directive also incorporates two elements of the Basel III accordnamely the introduction of two capital buffers on top of the minimum capital require-ments the capital conservation buffer identical for all banks in the EU and the countercy-clical capital buffer to be determined at national level The proposed EU regulation(CRR) (Commission 2011b) contains prudential requirements for credit institutions andinvestment firms The proposed regulation covers the definition of capital increasing theamount of own funds that banks need to hold as well as the quality of those funds itintroduces the Liquidity Coverage Ratio ndash the exact composition and calibration of whichwill be determined after an observation and review period in 2015 and the need to con-sider a leverage ratio subject to supervisory review

The Commissionrsquos CRDIV draft was criticised for watering down or modifying theBasel III guidelines in ways to meet EU member state demands (International MonetaryFund 2011) The Commission lsquosoftenedrsquo its definition of Core Tier I capital relative tothe Basel III recommendations in some areas For example it allowed lsquosilent participa-tionsrsquo that is state loans that make up a significant part of public Landesbanken capitalin Germany The Commissionrsquos draft limited the role of the leverage ratio designed tolimit risk-taking at banks On liquidity the Commissionrsquos draft adopted a less prescriptivedefinition of liquid assets and lacks a firm commitment to implement the Net StableFunding Ratio The proposed regulation also sets higher capital requirements for Overthe Counter (OTC) derivatives that are not cleared through Central Counterparties

The use of a regulation which once approved is directly applicable without the needfor national transposition was designed to ensure the creation of a single rule book inthe EU The regulation eliminates a key source of national divergence In the CRD IImore than 100 national discretions (differences in national legislation transposing the EUdirective) remained The Commission also proposed a maximum capital ratio that wasopposed by those such as UK policy-makers who argued in favour of EU standards thatexceed the Basel minimum Indeed in the negotiations of the new capital requirements inBasel and Brussels British policy-makers favoured strict rules on capital and liquidityBy contrast French and German policy-makers supported lsquosofterrsquo rules These memberstates the European Parliament (EP) and the Commission called for taking into accountlsquoEuropean specificitiesrsquo in incorporating the Basel III rules into the CRD IV reopeningsome of the issues that had caused friction within the BCBS Indeed the ongoing negoti-ations of this legislation are slowed down by different national preferences across themember state which in turn are due to the likely effects of the new rules in the memberstates (Howarth and Quaglia forthcoming)

Directive establishing the framework for the recovery and resolution of credit institutionsand investment firms

During the financial crisis several large banks were bailed out with public funds becausethey were considered lsquotoo big to failrsquo In June 2012 the Commission adopted a legislativeproposal for bank recovery and resolution (Commission 2012b) designed to avoid govern-ment bailout of large banks in the future The scope of application of the proposal was thesame as the CRD discussed above hence it applied to all credit institutions and certaininvestment firms The proposal distinguished between powers of lsquopreventionrsquo lsquoearly inter-ventionrsquo and lsquoresolutionrsquo In the case of prevention banks are required to draw up recoveryplans and resolution authorities are required to prepare resolution plans both at group level

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and for the individual institutions within the group Authorities can require a bank tochange its legal or operational structures to ensure that it can be resolved with the availabletools Financial groups may enter into intra-group support agreements in the form of loansor the provision of guarantees The framework envisages early supervisory interventionwhereby the authorities could require banks to implement measures set out in the recoveryplan and would have the power to appoint a special manager at a bank for a limited period

The harmonised resolution tools and powers outlined in the directive are designed toensure that national authorities in all member states have a common toolkit and roadmapto manage the failure of banks Amongst the tools considered there is the bail-in toolwhereby banks would be recapitalised with shareholders wiped out or diluted and credi-tors would have their claims reduced or converted to shares Resolution colleges are tobe established under the leadership of the group resolution authority and with the partici-pation of the European Banking Authority (EBA) The EBA will facilitate joint actionsand act as a binding mediator if necessary

The legislation envisaged the creation of resolution funding which would raise contri-butions from banks proportionate to their liabilities and risk profiles and would not beused to bail out a bank There is a link between this piece of legislation and the directiveon DGS which will provide funding for the protection of retail depositors Member stateswill be allowed to merge these two funds provided that the scheme remains in positionto repay depositors in case of failure The Commission noted that ideally a single pan-European fund should be established with a pan-European resolution authority to manageits disbursal but the absence of a single European banking supervisor and insolvencyregime would make this unworkable1 As in the case of the DGS the obstacles to thesefar-reaching changes were ultimately political as explained in Section 3 and negotiationsare ongoing

Securities markets regulation in the EU

Regulation on Credit Rating Agencies

In the securities sector Credit Rating Agencies (CRAs) were singled out amongst the mainculprits of the crisis for failing to rate properly financial products (Brunnermeier et al2009) They substantially over-rated many complex securities created through the financialactivity of securitisation and were slow in revising their ratings once market conditionsdeteriorated The over-generous rating of securities was influenced by the strong competi-tion taking place between CRAs in order to attract clients and by conflicts of interestbecause CRAs provided a variety of other services to the potential issuers requiring ratinghence they had strong incentives to be generous in their assessment of creditworthiness

Prior to the crisis CRAs were regulated internationally by a voluntary Code of Con-duct Fundamentals issued by IOSCO in 2004 and revised in the wake of the crisis in2008 The EU had considered and then ruled out specific EU rules on CRAs (Muumlgge2011) After the crisis the French presidency of the EU in the second semester of 2008implicitly made EU legislation on CRAs one of its priorities The European Council calledfor a legislative proposal to strengthen the rules on credit rating agencies and their supervi-sion at EU level in October 2008 (Quaglia 2009) Influential MEPs supported the regula-tion of CRAs in the EU The (revised) IOSCO Code provided the benchmark for theCommissionrsquos draft regulation on CRAs However the Commission argued that theIOSCO rules needed to be made more concrete and be backed by enforcement (Moschella2011 Pagliari 2011)

Journal of Economic Policy Reform 21

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The Regulation on CRAs was agreed relatively quickly by the EU in less than a yearAccording to the new rules all CRAs whose ratings are used in the EU need to applyfor registration in the EU and have to comply with rules designed to prevent conflict ofinterest in the rating process and to ensure the quality of the rating methodology and theratings CRAs operating in non-EU jurisdictions can issue ratings to be used in the EUprovided that their countries of origin have a regulatory framework recognised as equiva-lent to the one put in place by the EU or that such ratings are endorsed by an EU-regis-tered CRA (Council of Ministers and European Parliament 2009)

In June 2010 the Commission proposed an amendment of the Regulation on CRAsadopted in 2009 Since ratings issued by a CRA can be used by financial institutionsthroughout the EU the Commission proposed a more centralised system for supervisionof CRAs whereby the newly created European Securities and Markets Authority (ESMAdiscussed below) was entrusted with exclusive supervisory powers over CRAs registeredin the EU including European subsidiaries of US-headquartered CRAs such as FitchMoody and Standard amp Poor The ESMA was given powers to request information tolaunch investigations and to perform on-site inspections The amended regulation wasadopted by the Council and the EP in May 2011 (Council of Ministers and European Par-liament 2011) In the summer of 2011 the downgrading of the government bonds in thecountries directly hit by the sovereign debt crisis by the (mainly US-headquartered)CRAs gave new momentum to the debate on the creation of the European rating agencya proposal that was put forward by the EP

Alternative Investment Funds Managers Directive

The attempt to regulate hedge funds in the EU was given new momentum by the finan-cial crisis (see Broby 2012) In June 2009 the European Commission presented its pro-posal for the draft directive on AIFMs (Alternative Investment Funds Managers) whichincluded managers of hedge funds private equities funds and real estate funds hencecovering quite a broad range of financial entities The main sponsors of the directive wereFrance Germany Italy whereas the UK some Northern countries and AIFMs reluctantlyagreed to it and only after some of its most controversial provisions were watered down(see Buckley and Howarth 2010 Quaglia 2011 Woll 2012) After intense lobbying fromindustry the US and the UK the draft directive was partly revised during the Swedishpresidency2 of the EU in the second semester of 2009 An agreement between the Coun-cil of Ministers and the EP was eventually reached in late October 2010 and the direc-tive is due to enter into force in 2013

It introduces a legally binding authorisation and supervisory regime for all AIFMs inthe EU irrespective of the legal domicile of the alternative investment funds managedHence AIFMs will be subject to authorisation from the competent authority of the homemember state and to reporting requirements of systemically important data to supervisorsThe directive sets up a European passport for AIFMs Hence an AIFM authorised in itshome member state will be entitled to market its funds to professional investors in othermember states which will not be permitted to impose additional requirements (Councilof Ministers and European Parliament 2011)

European Market Infrastructure Regulation

Prior to the global financial crisis a large number of derivatives were traded over thecounter (OTC) not through stock exchanges and were not cleared through central

22 L Quaglia

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counterparties (CCPs) Derivative trading on stock exchanges increases transparency andcentral counterparties reduce counterparty risk (ie the risk of default by one party to thecontract) so that the default of one market participant would not cause the collapse ofother market players thereby putting the entire financial system at risk The OTC deriva-tives comprise a wide variety of products (interest rates credit equity foreign exchangeand commodities) with different characteristics They are used in a variety of waysincluding for purposes of hedging investing and speculating OTC derivatives accountfor almost 90 of the derivatives markets The default of Lehman Brothers and thebailout of AIG highlighted the need to get more reliable information on what goes on inthe OTC derivatives market which in the past had remained outside the perimeter of reg-ulation In the past the US and the UK authorities had adamantly opposed regulatingderivatives They no longer did so after the crisis (on the EU-US regulatory relationsafter the crisis see Pagliari 2012)

In September 2010 the Commission proposed the European Market InfrastructureRegulation (EMIR (Commission 2010d)) The proposed legislation aimed to ensure thetransparency of OTC derivatives transactions and to reduce the risks associated with theseproducts by shifting where possible OTC derivatives trading to CCPs These CCPs wouldreduce counterparty risks because they act as intermediaries between sellers and buyersof derivative products They would ensure the solvency of their participants by requestingdeposits and margin calls The proposed regulation also would involve the creation ofharmonised rules for CCPs and EU supervision of trade repositories The reporting of alltransactions would be mandatory and would provide supervisory authorities with the fullpicture of these markets

EMIR was considered a critical piece of legislation by the Commission and Mem-ber States in order to meet G20 commitments at the September 2009 Pittsburgh sum-mit It was initially conceived by the Commission as a directive but it quicklychanged to become a regulation This distinction is important because as explainedabove regulations are enacted into law with immediate effect in EU member stateswith no discretion over their interpretation EMIR was driven by the Commission withsupport from Germany and France The British government was broadly in favour butopposed certain elements of the proposed legislation (see Buckley et al 2012) TheParliament and the Council agreed on their negotiating positions in July 2011 andOctober 2011 respectively Subsequently a trialogue between the Council the Parlia-ment and the Commission took place The final (Level 1) text of the regulation wasfinally agreed in March 2012 In 2012 the ESMA began drafting Level 2 rules thatsupport the Level 1 regulation

Financial supervision in the EU

The global financial crisis revealed the weaknesses of existing macro-prudential oversightin the EU and the inadequacy of nationally-based supervisory models in overseeing inte-grated financial markets with cross-border operators (Group of Thirty 2009) It exposedshortcomings in the consistent application of Community law (the lack of a Europeanrule book) as well as insufficient cooperation between supervisors in exchanging infor-mation and in crisis management In 2009 a group of high level practitioners and finan-cial experts chaired by the former governor of the Banque de France produced a reporton the issue which was named after the chair of the group (de Larosiegravere Group 2009)Building on the de Larosierersquos report in September 2009 the Commission put forward a

Journal of Economic Policy Reform 23

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series of legislative proposals for the reform of the micro- and macro-prudential frame-work for financial supervision in the EU The Commission proposals were eventuallyagreed by the Council and European Parliament in the autumn of 2010 and were imple-mented in early 20113

The main institutional innovations were the establishment of the European SystemicRisk Board its chair to be elected by and from the members of the General Council ofthe European Central Bank (ECB) and in charge of monitoring macro-prudential risk thetransformation of the so-called level three Lamfalussy committees of national regulatorsinto independent authorities with legal personality an increased budget and enhancedpowers The newly created bodies namely the European Banking Authority the Euro-pean Insurance and Occupational Pension Authority and the European Securities MarketsAuthority were charged with the tasks of coordinating the application of supervisorystandards and promoting stronger cooperation between national supervisors Moreoverindividual ESAs were given specific roles for example ESMA is the EU supervisor ofcredit rating agencies while EBA and EIOPA carry out lsquostress testsrsquo of their respectivesectors Yet the new agencies have limited competences and their effective ability toregulate the financial sector remains to be seen

In the negotiations of these institutional reforms disagreements broke out in the Coun-cil and between the Council and the EP concerning the powers of the newly createdbodies as well as the role of the EP in the proposed architecture In the Council therewere (mainly British) concerns about giving the new authorities powers over national reg-ulators and the possibility of supervising individual financial cross-border institutions(Buckley and Howarth 2010) Besides the UK Ireland and Luxemburg were also reluctantto transfer powers away from national supervisors to bodies outside their borders More-over the UK government was reluctant to grant decision-making powers to EU-levelbodies while public funds to tackle banking crises came from national budgets To thiseffect Gordon Brown the British Prime Minister secured a guarantee that the new super-visory system would not include powers to force national governments to bail out banksThat said a number of Member States particularly those with large financial centresnamely the UK France and Germany favoured the limited reform approach and were hes-itant about transferring substantive power to the EU level (Buckley and Howarth 2010)This led to a significant reduction in the scope of the Commission proposals during thenegotiations in the Council By contrast the EP argued that the Commissionrsquos proposalsdid not go far enough and was adamant about safeguarding the powers of the ESAs andenhancing its own oversight role To some extent it was successful in doing so

The Banking Union

The belated banking crisis in Spain (see Royo forthcoming) which risked wreaking thepublic finance in this country exposed the vicious circle between the sovereign debt cri-sis and the financial (meaning banking) crisis In June 2012 the European Council andEuro Area summit agreed to deepen Economic and Monetary Union creating a lsquoBankingUnionrsquo (Euroarea statement 2012) This Union was to be based on four components asingle rulebook more integrated banking supervision a pan-EU deposit guaranteescheme a common EU-wide framework for the managed resolution of banks and finan-cial institutions The Member States decided to make the set-up of a single supervisorymechanism a precondition for the possible direct recapitalisation of banks by the Euro-pean Stability Mechanism (ESM) created to deal with the sovereign debt crisis

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In September 2012 the Commission adopted a set of legislative proposals on theestablishment of a single supervisory mechanism led by the ECB The proposals con-cerned a regulation giving strong powers for the supervision of all banks in the euro areato the ECB and national supervisory authorities a regulation with limited specificchanges to the regulation setting up the European Banking Authority (EBA) to ensure abalance in its decision making structures between the euro area and non-euro area Mem-ber States a communication on a roadmap for completing the banking union over thecoming years covering the single rulebook common deposit protection and a single bankresolution mechanism4

In the new single mechanism ultimate responsibility for specific supervisory tasksrelated to the financial stability of all Euro area banks will lie with the ECB Nationalsupervisors will continue to play an important role in day-to-day supervision and in pre-paring and implementing ECB decisions The ECB will become responsible for taskssuch as authorising credit institutions compliance with capital leverage and liquidityrequirements and conducting supervision of financial conglomerates (Commission of theEuropean Communities 2012a) The ECB will be able to carry out early interventionmeasures when a bank breaches or risks breaching regulatory capital requirements byrequiring banks to take remedial action The Commission also proposed the developmentof the Single Supervisory Handbook by the European Banking Authority (EBA)

The ECB will cooperate with the EBA within the framework of the European Systemof financial supervision The role of the EBA will be similar to today it will continuedeveloping the single rulebook applicable to all 27 Member States and make sure thatsupervisory practices are consistent across the whole Union5 After agreement on thepending proposals as a next step the Commission envisages making a proposal for a sin-gle European resolution mechanism The political discussions on this reform are stillongoing

3 An overall assessment of the reforms in the EU and the main open issues

Three main features of the regulatory measures adopted or officially proposed by the EUin the wake of the crisis stand out First the reforms enacted either regulated activities orfinancial institutions that were previously unregulated in the EU and its member states(CRAs) or at the EU level (AIFMs) or at the national EU and international level(OTCDs) In other instances they imposed heavier more prescriptive and more burden-some requirements on financial entities that were already regulated prior to the crisis asin the case of higher capital requirements for banks and new liquidity management rules(Basel III) or they set in place more substantial protection for depositors (the DGSD)That said some key controversial issues discussed below were not fully addressed

Second although with some notable exceptions the new or amended rules were gen-erally resisted by the UK Ireland Luxemburg and a variable mix of Nordic countriesThe market players primarily affected by the new or revised rules such as CRAs andAIFMs initially resisted the proposed rules Subsequently they engaged in intense lobby-ing with a view to having the proposed rules amended on the grounds that they would beover-prescriptive and costly to implement creating potential regulatory arbitrage vis-agrave-viscountries outside the EU (Quaglia 2012) A somewhat special case was the new capitaland liquidity rules whereby the UK favoured new strict rules on capital requirementsand liquidity provisions whereas France Germany and Italy called for lsquosofterrsquo rules anda longer transition period

Journal of Economic Policy Reform 25

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13

Third the pace of reform was somewhat piecemeal in the EU This has partly to dowith the interlocking mechanisms of policy making in the EU where there are severalveto players The main agenda-setter of the reform efforts was the Commission which isthe only body that can officially propose legislation in the EU Of course the Commis-sion did so after consulting the member states informally and after holding open publicconsultations In certain cases the Commission was spurred to act by the initiatives ofthe EP as in the case of CRAs and by the continental member states as in the case ofAIFM The Council and the EP were the main decision-makers because they had thepower to adopt or amend the legislation proposed by the Commission Often the memberstates had different priorities and they were worried about potential regulatory arbitragewith jurisdictions outside the EU Lobbying from the financial industry which was keento limit the extent of regulatory change at the national EU and international levels insome cases watered down the proposed reforms but so did the political disagreementbetween the member states

Several problematic issues were highlighted by the crisis and they were only partiallyaddressed by the reforms implemented by the EU afterward The first is the disjuncturebetween globalised financial markets financial market integration in the EU EU financialregulation and national systems of supervision A vast body of international politicaleconomy literature has discussed the internationalisation or globalisation of finance fromthe 1990s onwards (see Helleiner 1994) Financial market integration in the EU substan-tially intensified after the introduction of the single currency and the completion of thesingle market in financial services envisaged by the Financial Services Action Plan in1999 EU rules to a large extent provide the framework for financial regulation in themember states However EU rules are also embedded into or coexist with internationalrules on certain activities The most notable examples are capital requirements for banksset by the Basel accords Unlike financial regulation which is mostly set at the EU levelfinancial supervision in the EU is mainly carried out at the national level by central banks(whenever they are responsible for banking supervision) or the banking supervisoryauthorities if separated from the central bank and the supervisors of other financial activ-ities (eg securities markets)

This fragmentation of powers and responsibilities severely constrains the publicauthoritiesrsquo ability to supervise financial markets and financial entities active in theirjurisdictions This is particularly problematic in the case of ailing cross-border financialinstitutions whereby the key issue is burden sharing that isrsquo the distribution of costsbetween the home and host countries and across the host jurisdictions in which cross-bor-der financial institutions operate (see Dyson and Quaglia 2010) Furthermore sometimesfinancial institutions are too big to be rescued by their home countries ultimately by thetreasury and taxpayers of the country in which they are headquartered This was the caseof the Icelandic banks operating cross-border in the EU This is a challenge not only forthe small countries but also for the large ones that are home countries of very big finan-cial entities For example the Deutsche Bank balance sheet amount to a significant shareof German GDP

Moreover the banking system of several central and eastern European countries is lar-gely foreign owned This raises three main concerns First there are banks that are ofsystemic importance in the new member states but not in the country in which they areheadquartered Second host supervisors can exert only limited control on foreign banksoperating in their jurisdictions particularly when they take the legal form of branchesThis point was stressed in the Turner report 2010 (Financial Services Authority 2009)which went as far as suggesting the compulsory transformation of branches into

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subsidiaries under specific circumstances In the case of subsidiaries which are separatelegal entities in the countries in which they operate key functions might well be centra-lised within the financial groups of which such subsidiaries are part de facto limiting thepower of the host country supervisors Thirdly there is the risk that as a consequence ofthe financial turmoil such banks might retreat (ie pull out funding) abruptly from thehost countries

The bank resolution regime proposed by the Commission in June 2012 after years ofpreparation and several rounds of public consultations does not fully address these short-comings Nor does the DGS directive Ultimately there is an inescapable link betweenfinancial supervision crisis management and resolution and fiscal power (that is theability to use taxpayer money to deal with ailing banks) Fiscal policy goes to the core ofnational sovereignty which explains the reluctance of member states to the creation ofpan-European institutions (be they DGS funds resolution funds or resolution authorities)in this field Moreover the costs and the benefits ensuing from the establishment of theseinstitutions are likely to be unequally distributed across the member states In the endcountries with sound banking systems will have to foot the bill of crisis resolution incountries with less stable banking systems All this raises the problem of the under provi-sion of the public good of financial stability meaning that everybody benefits from finan-cial stability but the costs of providing this public good tend to be specific

Second the global financial crisis brought into sharp relief the interconnection betweenmonetary policy macroeconomic imbalances and financial stability in particular theeffects that the former can have on the latter (see Aktas and Cortuk 2012) Several authorshave pointed out the effects of macroeconomic imbalances such as the permanent deficitsin the US balance of payments (Pauly 2009) and of relatively accommodating monetarypolicies in the US but also to some extent in the EU (Carmassi et al 2009) in fuelling theglobal financial crisis Moreover deficits in the balance of payments are generally accom-panied by fiscal imbalances in particular in Southern Europe where the sovereign debtcrisis followed the financial crisis In turn the sovereign debt crisis risked turning into abanking crisis showing the interconnection between the two types of crises (for a discus-sion of several interesting country studies see Hardie and Howarth forthcoming)

In some countries such as Ireland it was the financial crisis and ultimately the statersquosrescue of the banking system that substantially worsened the public finances (public defi-cit and debt) triggering the sovereign debt crisis In other countries such as Italy andGreece the sovereign debt crisis had domestic origins it was rooted in a loose fiscal pol-icy while the national banking sector was relatively sound and only marginally affectedby the financial (banking) crisis However once the Greek and Italian state faced defaulttheir banking systems were penalised and the sovereign debt crisis risked turning into abanking crisis The problems experienced by some Spanish banks gave new momentumto the idea of a banking union discussed above highlighting the vicious circle betweenbanks and sovereigns Especially in the case of the sovereign debt crisis some commen-tators have argued that the EU and in particular the European Commission is reactive notproactive For example the Nobel-laureate US economist Paul Krugman pointed outthe need for lsquoa Marshall plan for Europersquo (The Guardian 22 January 2012 see alsoKrugman 2012ab)

Conclusions

This article has examined the regulatory response of the EU to the financial crisis endingwith a concise discussion of the link between the financial crisis and the sovereign debt

Journal of Economic Policy Reform 27

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crisis Set against the benchmarks outlined in the introduction it is possible to concludethat despite the new pieces of legislation adopted by the EU the framework for financialservices regulation and supervision in the EU is not substantially different from the pre-crisis one The main obstacles to more far-reaching reform were political not economic

The EU is generally a slow moving institution and tends to be reactive rather thanproactive It took the Commission more than three years and several rounds of consulta-tion to come forward with a formal legislative proposal for a banking resolution regimeNegotiations in the Council and EP have just started and are likely to be time consumingThe DGS directive officially proposed by the Commission in 2010 has not yet beenagreed The proposed Banking Union would represent quite a major reform Yet it is farfrom being agreed and political discussions are ongoing

The Commission is also trying to grapple with structural issues concerning the bank-ing sector in the EU In February 2012 it appointed a High-level Expert Group headedby Erkki Liikanen (former governor of the central bank of Finland) to examine structuralreforms that would directly affect the structure of individual banks and the market as awhole (High Level Expert Group 2012)6 Such reforms could for example includeprohibiting banks from carrying out some activities such as proprietary trading (asenvisaged in the Dodd-Frank act in the US) or requiring banks to ring-fence theirdeposit-taking activities from investment banking as proposed by the IndependentBanking Commission in the UK In this case as well the jury is still out

AcknowledgementsThe author wishes to acknowledge financial support from the European Research Council (204398FINGOVEU) and the British Academy (SG 120191) This paper was written while the author wasa visiting fellow at the Max Planck Institute the European University Institute and HanseWissenschaftskolleg

Notes1 httpeuropaeurapidpressReleasesActiondoreference=MEMO12416ampfor-

mat=HTMLampaged=0amplanguage=ENampguiLanguage=en2 Sweden has a significant private equity industry hence it was seen as having a vested interest

in the revision of the text of the directive3 All these legislative texts can be found at httpeceuropaeuinternal_marketfinancescommit-

teesindex_enhtm4 httpeuropaeurapidpress-release_MEMO-12-656_enhtmlocale=en5 httpeuropaeurapidpress-release_IP-12-953_enhtmlocale=en6 httpeuropaeurapidpressReleasesActiondoreference=MEMO12129ampfor-

mat=HTMLampaged=1amplanguage=ENampguiLanguage=en]

ReferencesAktas C and Cortuk O 2012 Turkeyrsquos experience with the global crisis restructuring policies

within a financial stability framework Journal of Economic Policy Reform 15 (3) 195ndash205Baker A 2012 The new political economy of the macroprudential ideational shift New Political

Economy iFirstBasel Committee on Banking Supervision 2010a Basel III A global regulatory framework for

more resilient banks and banking systems DecemberBasel Committee on Banking Supervision 2010b Basel III International framework for liquidity

risk measurement standards and monitoring DecemberBroby D 2012 The regulatory evolution of the post credit crisis fund management industry

Journal of Economic Policy Reform 15 (1) 5ndash11Brunnermeier M Crockett A Goodhart C Persaud AD Shin HS 2009 The fundamental

principles of financial regulation Geneva Reports on the World Economy 11

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pursuit of the business of banks the conditions for the freedom of establishment and thefreedom to provide services the supervisory review process and the definition of compe-tent authorities The directive also incorporates two elements of the Basel III accordnamely the introduction of two capital buffers on top of the minimum capital require-ments the capital conservation buffer identical for all banks in the EU and the countercy-clical capital buffer to be determined at national level The proposed EU regulation(CRR) (Commission 2011b) contains prudential requirements for credit institutions andinvestment firms The proposed regulation covers the definition of capital increasing theamount of own funds that banks need to hold as well as the quality of those funds itintroduces the Liquidity Coverage Ratio ndash the exact composition and calibration of whichwill be determined after an observation and review period in 2015 and the need to con-sider a leverage ratio subject to supervisory review

The Commissionrsquos CRDIV draft was criticised for watering down or modifying theBasel III guidelines in ways to meet EU member state demands (International MonetaryFund 2011) The Commission lsquosoftenedrsquo its definition of Core Tier I capital relative tothe Basel III recommendations in some areas For example it allowed lsquosilent participa-tionsrsquo that is state loans that make up a significant part of public Landesbanken capitalin Germany The Commissionrsquos draft limited the role of the leverage ratio designed tolimit risk-taking at banks On liquidity the Commissionrsquos draft adopted a less prescriptivedefinition of liquid assets and lacks a firm commitment to implement the Net StableFunding Ratio The proposed regulation also sets higher capital requirements for Overthe Counter (OTC) derivatives that are not cleared through Central Counterparties

The use of a regulation which once approved is directly applicable without the needfor national transposition was designed to ensure the creation of a single rule book inthe EU The regulation eliminates a key source of national divergence In the CRD IImore than 100 national discretions (differences in national legislation transposing the EUdirective) remained The Commission also proposed a maximum capital ratio that wasopposed by those such as UK policy-makers who argued in favour of EU standards thatexceed the Basel minimum Indeed in the negotiations of the new capital requirements inBasel and Brussels British policy-makers favoured strict rules on capital and liquidityBy contrast French and German policy-makers supported lsquosofterrsquo rules These memberstates the European Parliament (EP) and the Commission called for taking into accountlsquoEuropean specificitiesrsquo in incorporating the Basel III rules into the CRD IV reopeningsome of the issues that had caused friction within the BCBS Indeed the ongoing negoti-ations of this legislation are slowed down by different national preferences across themember state which in turn are due to the likely effects of the new rules in the memberstates (Howarth and Quaglia forthcoming)

Directive establishing the framework for the recovery and resolution of credit institutionsand investment firms

During the financial crisis several large banks were bailed out with public funds becausethey were considered lsquotoo big to failrsquo In June 2012 the Commission adopted a legislativeproposal for bank recovery and resolution (Commission 2012b) designed to avoid govern-ment bailout of large banks in the future The scope of application of the proposal was thesame as the CRD discussed above hence it applied to all credit institutions and certaininvestment firms The proposal distinguished between powers of lsquopreventionrsquo lsquoearly inter-ventionrsquo and lsquoresolutionrsquo In the case of prevention banks are required to draw up recoveryplans and resolution authorities are required to prepare resolution plans both at group level

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and for the individual institutions within the group Authorities can require a bank tochange its legal or operational structures to ensure that it can be resolved with the availabletools Financial groups may enter into intra-group support agreements in the form of loansor the provision of guarantees The framework envisages early supervisory interventionwhereby the authorities could require banks to implement measures set out in the recoveryplan and would have the power to appoint a special manager at a bank for a limited period

The harmonised resolution tools and powers outlined in the directive are designed toensure that national authorities in all member states have a common toolkit and roadmapto manage the failure of banks Amongst the tools considered there is the bail-in toolwhereby banks would be recapitalised with shareholders wiped out or diluted and credi-tors would have their claims reduced or converted to shares Resolution colleges are tobe established under the leadership of the group resolution authority and with the partici-pation of the European Banking Authority (EBA) The EBA will facilitate joint actionsand act as a binding mediator if necessary

The legislation envisaged the creation of resolution funding which would raise contri-butions from banks proportionate to their liabilities and risk profiles and would not beused to bail out a bank There is a link between this piece of legislation and the directiveon DGS which will provide funding for the protection of retail depositors Member stateswill be allowed to merge these two funds provided that the scheme remains in positionto repay depositors in case of failure The Commission noted that ideally a single pan-European fund should be established with a pan-European resolution authority to manageits disbursal but the absence of a single European banking supervisor and insolvencyregime would make this unworkable1 As in the case of the DGS the obstacles to thesefar-reaching changes were ultimately political as explained in Section 3 and negotiationsare ongoing

Securities markets regulation in the EU

Regulation on Credit Rating Agencies

In the securities sector Credit Rating Agencies (CRAs) were singled out amongst the mainculprits of the crisis for failing to rate properly financial products (Brunnermeier et al2009) They substantially over-rated many complex securities created through the financialactivity of securitisation and were slow in revising their ratings once market conditionsdeteriorated The over-generous rating of securities was influenced by the strong competi-tion taking place between CRAs in order to attract clients and by conflicts of interestbecause CRAs provided a variety of other services to the potential issuers requiring ratinghence they had strong incentives to be generous in their assessment of creditworthiness

Prior to the crisis CRAs were regulated internationally by a voluntary Code of Con-duct Fundamentals issued by IOSCO in 2004 and revised in the wake of the crisis in2008 The EU had considered and then ruled out specific EU rules on CRAs (Muumlgge2011) After the crisis the French presidency of the EU in the second semester of 2008implicitly made EU legislation on CRAs one of its priorities The European Council calledfor a legislative proposal to strengthen the rules on credit rating agencies and their supervi-sion at EU level in October 2008 (Quaglia 2009) Influential MEPs supported the regula-tion of CRAs in the EU The (revised) IOSCO Code provided the benchmark for theCommissionrsquos draft regulation on CRAs However the Commission argued that theIOSCO rules needed to be made more concrete and be backed by enforcement (Moschella2011 Pagliari 2011)

Journal of Economic Policy Reform 21

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The Regulation on CRAs was agreed relatively quickly by the EU in less than a yearAccording to the new rules all CRAs whose ratings are used in the EU need to applyfor registration in the EU and have to comply with rules designed to prevent conflict ofinterest in the rating process and to ensure the quality of the rating methodology and theratings CRAs operating in non-EU jurisdictions can issue ratings to be used in the EUprovided that their countries of origin have a regulatory framework recognised as equiva-lent to the one put in place by the EU or that such ratings are endorsed by an EU-regis-tered CRA (Council of Ministers and European Parliament 2009)

In June 2010 the Commission proposed an amendment of the Regulation on CRAsadopted in 2009 Since ratings issued by a CRA can be used by financial institutionsthroughout the EU the Commission proposed a more centralised system for supervisionof CRAs whereby the newly created European Securities and Markets Authority (ESMAdiscussed below) was entrusted with exclusive supervisory powers over CRAs registeredin the EU including European subsidiaries of US-headquartered CRAs such as FitchMoody and Standard amp Poor The ESMA was given powers to request information tolaunch investigations and to perform on-site inspections The amended regulation wasadopted by the Council and the EP in May 2011 (Council of Ministers and European Par-liament 2011) In the summer of 2011 the downgrading of the government bonds in thecountries directly hit by the sovereign debt crisis by the (mainly US-headquartered)CRAs gave new momentum to the debate on the creation of the European rating agencya proposal that was put forward by the EP

Alternative Investment Funds Managers Directive

The attempt to regulate hedge funds in the EU was given new momentum by the finan-cial crisis (see Broby 2012) In June 2009 the European Commission presented its pro-posal for the draft directive on AIFMs (Alternative Investment Funds Managers) whichincluded managers of hedge funds private equities funds and real estate funds hencecovering quite a broad range of financial entities The main sponsors of the directive wereFrance Germany Italy whereas the UK some Northern countries and AIFMs reluctantlyagreed to it and only after some of its most controversial provisions were watered down(see Buckley and Howarth 2010 Quaglia 2011 Woll 2012) After intense lobbying fromindustry the US and the UK the draft directive was partly revised during the Swedishpresidency2 of the EU in the second semester of 2009 An agreement between the Coun-cil of Ministers and the EP was eventually reached in late October 2010 and the direc-tive is due to enter into force in 2013

It introduces a legally binding authorisation and supervisory regime for all AIFMs inthe EU irrespective of the legal domicile of the alternative investment funds managedHence AIFMs will be subject to authorisation from the competent authority of the homemember state and to reporting requirements of systemically important data to supervisorsThe directive sets up a European passport for AIFMs Hence an AIFM authorised in itshome member state will be entitled to market its funds to professional investors in othermember states which will not be permitted to impose additional requirements (Councilof Ministers and European Parliament 2011)

European Market Infrastructure Regulation

Prior to the global financial crisis a large number of derivatives were traded over thecounter (OTC) not through stock exchanges and were not cleared through central

22 L Quaglia

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counterparties (CCPs) Derivative trading on stock exchanges increases transparency andcentral counterparties reduce counterparty risk (ie the risk of default by one party to thecontract) so that the default of one market participant would not cause the collapse ofother market players thereby putting the entire financial system at risk The OTC deriva-tives comprise a wide variety of products (interest rates credit equity foreign exchangeand commodities) with different characteristics They are used in a variety of waysincluding for purposes of hedging investing and speculating OTC derivatives accountfor almost 90 of the derivatives markets The default of Lehman Brothers and thebailout of AIG highlighted the need to get more reliable information on what goes on inthe OTC derivatives market which in the past had remained outside the perimeter of reg-ulation In the past the US and the UK authorities had adamantly opposed regulatingderivatives They no longer did so after the crisis (on the EU-US regulatory relationsafter the crisis see Pagliari 2012)

In September 2010 the Commission proposed the European Market InfrastructureRegulation (EMIR (Commission 2010d)) The proposed legislation aimed to ensure thetransparency of OTC derivatives transactions and to reduce the risks associated with theseproducts by shifting where possible OTC derivatives trading to CCPs These CCPs wouldreduce counterparty risks because they act as intermediaries between sellers and buyersof derivative products They would ensure the solvency of their participants by requestingdeposits and margin calls The proposed regulation also would involve the creation ofharmonised rules for CCPs and EU supervision of trade repositories The reporting of alltransactions would be mandatory and would provide supervisory authorities with the fullpicture of these markets

EMIR was considered a critical piece of legislation by the Commission and Mem-ber States in order to meet G20 commitments at the September 2009 Pittsburgh sum-mit It was initially conceived by the Commission as a directive but it quicklychanged to become a regulation This distinction is important because as explainedabove regulations are enacted into law with immediate effect in EU member stateswith no discretion over their interpretation EMIR was driven by the Commission withsupport from Germany and France The British government was broadly in favour butopposed certain elements of the proposed legislation (see Buckley et al 2012) TheParliament and the Council agreed on their negotiating positions in July 2011 andOctober 2011 respectively Subsequently a trialogue between the Council the Parlia-ment and the Commission took place The final (Level 1) text of the regulation wasfinally agreed in March 2012 In 2012 the ESMA began drafting Level 2 rules thatsupport the Level 1 regulation

Financial supervision in the EU

The global financial crisis revealed the weaknesses of existing macro-prudential oversightin the EU and the inadequacy of nationally-based supervisory models in overseeing inte-grated financial markets with cross-border operators (Group of Thirty 2009) It exposedshortcomings in the consistent application of Community law (the lack of a Europeanrule book) as well as insufficient cooperation between supervisors in exchanging infor-mation and in crisis management In 2009 a group of high level practitioners and finan-cial experts chaired by the former governor of the Banque de France produced a reporton the issue which was named after the chair of the group (de Larosiegravere Group 2009)Building on the de Larosierersquos report in September 2009 the Commission put forward a

Journal of Economic Policy Reform 23

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series of legislative proposals for the reform of the micro- and macro-prudential frame-work for financial supervision in the EU The Commission proposals were eventuallyagreed by the Council and European Parliament in the autumn of 2010 and were imple-mented in early 20113

The main institutional innovations were the establishment of the European SystemicRisk Board its chair to be elected by and from the members of the General Council ofthe European Central Bank (ECB) and in charge of monitoring macro-prudential risk thetransformation of the so-called level three Lamfalussy committees of national regulatorsinto independent authorities with legal personality an increased budget and enhancedpowers The newly created bodies namely the European Banking Authority the Euro-pean Insurance and Occupational Pension Authority and the European Securities MarketsAuthority were charged with the tasks of coordinating the application of supervisorystandards and promoting stronger cooperation between national supervisors Moreoverindividual ESAs were given specific roles for example ESMA is the EU supervisor ofcredit rating agencies while EBA and EIOPA carry out lsquostress testsrsquo of their respectivesectors Yet the new agencies have limited competences and their effective ability toregulate the financial sector remains to be seen

In the negotiations of these institutional reforms disagreements broke out in the Coun-cil and between the Council and the EP concerning the powers of the newly createdbodies as well as the role of the EP in the proposed architecture In the Council therewere (mainly British) concerns about giving the new authorities powers over national reg-ulators and the possibility of supervising individual financial cross-border institutions(Buckley and Howarth 2010) Besides the UK Ireland and Luxemburg were also reluctantto transfer powers away from national supervisors to bodies outside their borders More-over the UK government was reluctant to grant decision-making powers to EU-levelbodies while public funds to tackle banking crises came from national budgets To thiseffect Gordon Brown the British Prime Minister secured a guarantee that the new super-visory system would not include powers to force national governments to bail out banksThat said a number of Member States particularly those with large financial centresnamely the UK France and Germany favoured the limited reform approach and were hes-itant about transferring substantive power to the EU level (Buckley and Howarth 2010)This led to a significant reduction in the scope of the Commission proposals during thenegotiations in the Council By contrast the EP argued that the Commissionrsquos proposalsdid not go far enough and was adamant about safeguarding the powers of the ESAs andenhancing its own oversight role To some extent it was successful in doing so

The Banking Union

The belated banking crisis in Spain (see Royo forthcoming) which risked wreaking thepublic finance in this country exposed the vicious circle between the sovereign debt cri-sis and the financial (meaning banking) crisis In June 2012 the European Council andEuro Area summit agreed to deepen Economic and Monetary Union creating a lsquoBankingUnionrsquo (Euroarea statement 2012) This Union was to be based on four components asingle rulebook more integrated banking supervision a pan-EU deposit guaranteescheme a common EU-wide framework for the managed resolution of banks and finan-cial institutions The Member States decided to make the set-up of a single supervisorymechanism a precondition for the possible direct recapitalisation of banks by the Euro-pean Stability Mechanism (ESM) created to deal with the sovereign debt crisis

24 L Quaglia

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In September 2012 the Commission adopted a set of legislative proposals on theestablishment of a single supervisory mechanism led by the ECB The proposals con-cerned a regulation giving strong powers for the supervision of all banks in the euro areato the ECB and national supervisory authorities a regulation with limited specificchanges to the regulation setting up the European Banking Authority (EBA) to ensure abalance in its decision making structures between the euro area and non-euro area Mem-ber States a communication on a roadmap for completing the banking union over thecoming years covering the single rulebook common deposit protection and a single bankresolution mechanism4

In the new single mechanism ultimate responsibility for specific supervisory tasksrelated to the financial stability of all Euro area banks will lie with the ECB Nationalsupervisors will continue to play an important role in day-to-day supervision and in pre-paring and implementing ECB decisions The ECB will become responsible for taskssuch as authorising credit institutions compliance with capital leverage and liquidityrequirements and conducting supervision of financial conglomerates (Commission of theEuropean Communities 2012a) The ECB will be able to carry out early interventionmeasures when a bank breaches or risks breaching regulatory capital requirements byrequiring banks to take remedial action The Commission also proposed the developmentof the Single Supervisory Handbook by the European Banking Authority (EBA)

The ECB will cooperate with the EBA within the framework of the European Systemof financial supervision The role of the EBA will be similar to today it will continuedeveloping the single rulebook applicable to all 27 Member States and make sure thatsupervisory practices are consistent across the whole Union5 After agreement on thepending proposals as a next step the Commission envisages making a proposal for a sin-gle European resolution mechanism The political discussions on this reform are stillongoing

3 An overall assessment of the reforms in the EU and the main open issues

Three main features of the regulatory measures adopted or officially proposed by the EUin the wake of the crisis stand out First the reforms enacted either regulated activities orfinancial institutions that were previously unregulated in the EU and its member states(CRAs) or at the EU level (AIFMs) or at the national EU and international level(OTCDs) In other instances they imposed heavier more prescriptive and more burden-some requirements on financial entities that were already regulated prior to the crisis asin the case of higher capital requirements for banks and new liquidity management rules(Basel III) or they set in place more substantial protection for depositors (the DGSD)That said some key controversial issues discussed below were not fully addressed

Second although with some notable exceptions the new or amended rules were gen-erally resisted by the UK Ireland Luxemburg and a variable mix of Nordic countriesThe market players primarily affected by the new or revised rules such as CRAs andAIFMs initially resisted the proposed rules Subsequently they engaged in intense lobby-ing with a view to having the proposed rules amended on the grounds that they would beover-prescriptive and costly to implement creating potential regulatory arbitrage vis-agrave-viscountries outside the EU (Quaglia 2012) A somewhat special case was the new capitaland liquidity rules whereby the UK favoured new strict rules on capital requirementsand liquidity provisions whereas France Germany and Italy called for lsquosofterrsquo rules anda longer transition period

Journal of Economic Policy Reform 25

Dow

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Third the pace of reform was somewhat piecemeal in the EU This has partly to dowith the interlocking mechanisms of policy making in the EU where there are severalveto players The main agenda-setter of the reform efforts was the Commission which isthe only body that can officially propose legislation in the EU Of course the Commis-sion did so after consulting the member states informally and after holding open publicconsultations In certain cases the Commission was spurred to act by the initiatives ofthe EP as in the case of CRAs and by the continental member states as in the case ofAIFM The Council and the EP were the main decision-makers because they had thepower to adopt or amend the legislation proposed by the Commission Often the memberstates had different priorities and they were worried about potential regulatory arbitragewith jurisdictions outside the EU Lobbying from the financial industry which was keento limit the extent of regulatory change at the national EU and international levels insome cases watered down the proposed reforms but so did the political disagreementbetween the member states

Several problematic issues were highlighted by the crisis and they were only partiallyaddressed by the reforms implemented by the EU afterward The first is the disjuncturebetween globalised financial markets financial market integration in the EU EU financialregulation and national systems of supervision A vast body of international politicaleconomy literature has discussed the internationalisation or globalisation of finance fromthe 1990s onwards (see Helleiner 1994) Financial market integration in the EU substan-tially intensified after the introduction of the single currency and the completion of thesingle market in financial services envisaged by the Financial Services Action Plan in1999 EU rules to a large extent provide the framework for financial regulation in themember states However EU rules are also embedded into or coexist with internationalrules on certain activities The most notable examples are capital requirements for banksset by the Basel accords Unlike financial regulation which is mostly set at the EU levelfinancial supervision in the EU is mainly carried out at the national level by central banks(whenever they are responsible for banking supervision) or the banking supervisoryauthorities if separated from the central bank and the supervisors of other financial activ-ities (eg securities markets)

This fragmentation of powers and responsibilities severely constrains the publicauthoritiesrsquo ability to supervise financial markets and financial entities active in theirjurisdictions This is particularly problematic in the case of ailing cross-border financialinstitutions whereby the key issue is burden sharing that isrsquo the distribution of costsbetween the home and host countries and across the host jurisdictions in which cross-bor-der financial institutions operate (see Dyson and Quaglia 2010) Furthermore sometimesfinancial institutions are too big to be rescued by their home countries ultimately by thetreasury and taxpayers of the country in which they are headquartered This was the caseof the Icelandic banks operating cross-border in the EU This is a challenge not only forthe small countries but also for the large ones that are home countries of very big finan-cial entities For example the Deutsche Bank balance sheet amount to a significant shareof German GDP

Moreover the banking system of several central and eastern European countries is lar-gely foreign owned This raises three main concerns First there are banks that are ofsystemic importance in the new member states but not in the country in which they areheadquartered Second host supervisors can exert only limited control on foreign banksoperating in their jurisdictions particularly when they take the legal form of branchesThis point was stressed in the Turner report 2010 (Financial Services Authority 2009)which went as far as suggesting the compulsory transformation of branches into

26 L Quaglia

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13

subsidiaries under specific circumstances In the case of subsidiaries which are separatelegal entities in the countries in which they operate key functions might well be centra-lised within the financial groups of which such subsidiaries are part de facto limiting thepower of the host country supervisors Thirdly there is the risk that as a consequence ofthe financial turmoil such banks might retreat (ie pull out funding) abruptly from thehost countries

The bank resolution regime proposed by the Commission in June 2012 after years ofpreparation and several rounds of public consultations does not fully address these short-comings Nor does the DGS directive Ultimately there is an inescapable link betweenfinancial supervision crisis management and resolution and fiscal power (that is theability to use taxpayer money to deal with ailing banks) Fiscal policy goes to the core ofnational sovereignty which explains the reluctance of member states to the creation ofpan-European institutions (be they DGS funds resolution funds or resolution authorities)in this field Moreover the costs and the benefits ensuing from the establishment of theseinstitutions are likely to be unequally distributed across the member states In the endcountries with sound banking systems will have to foot the bill of crisis resolution incountries with less stable banking systems All this raises the problem of the under provi-sion of the public good of financial stability meaning that everybody benefits from finan-cial stability but the costs of providing this public good tend to be specific

Second the global financial crisis brought into sharp relief the interconnection betweenmonetary policy macroeconomic imbalances and financial stability in particular theeffects that the former can have on the latter (see Aktas and Cortuk 2012) Several authorshave pointed out the effects of macroeconomic imbalances such as the permanent deficitsin the US balance of payments (Pauly 2009) and of relatively accommodating monetarypolicies in the US but also to some extent in the EU (Carmassi et al 2009) in fuelling theglobal financial crisis Moreover deficits in the balance of payments are generally accom-panied by fiscal imbalances in particular in Southern Europe where the sovereign debtcrisis followed the financial crisis In turn the sovereign debt crisis risked turning into abanking crisis showing the interconnection between the two types of crises (for a discus-sion of several interesting country studies see Hardie and Howarth forthcoming)

In some countries such as Ireland it was the financial crisis and ultimately the statersquosrescue of the banking system that substantially worsened the public finances (public defi-cit and debt) triggering the sovereign debt crisis In other countries such as Italy andGreece the sovereign debt crisis had domestic origins it was rooted in a loose fiscal pol-icy while the national banking sector was relatively sound and only marginally affectedby the financial (banking) crisis However once the Greek and Italian state faced defaulttheir banking systems were penalised and the sovereign debt crisis risked turning into abanking crisis The problems experienced by some Spanish banks gave new momentumto the idea of a banking union discussed above highlighting the vicious circle betweenbanks and sovereigns Especially in the case of the sovereign debt crisis some commen-tators have argued that the EU and in particular the European Commission is reactive notproactive For example the Nobel-laureate US economist Paul Krugman pointed outthe need for lsquoa Marshall plan for Europersquo (The Guardian 22 January 2012 see alsoKrugman 2012ab)

Conclusions

This article has examined the regulatory response of the EU to the financial crisis endingwith a concise discussion of the link between the financial crisis and the sovereign debt

Journal of Economic Policy Reform 27

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crisis Set against the benchmarks outlined in the introduction it is possible to concludethat despite the new pieces of legislation adopted by the EU the framework for financialservices regulation and supervision in the EU is not substantially different from the pre-crisis one The main obstacles to more far-reaching reform were political not economic

The EU is generally a slow moving institution and tends to be reactive rather thanproactive It took the Commission more than three years and several rounds of consulta-tion to come forward with a formal legislative proposal for a banking resolution regimeNegotiations in the Council and EP have just started and are likely to be time consumingThe DGS directive officially proposed by the Commission in 2010 has not yet beenagreed The proposed Banking Union would represent quite a major reform Yet it is farfrom being agreed and political discussions are ongoing

The Commission is also trying to grapple with structural issues concerning the bank-ing sector in the EU In February 2012 it appointed a High-level Expert Group headedby Erkki Liikanen (former governor of the central bank of Finland) to examine structuralreforms that would directly affect the structure of individual banks and the market as awhole (High Level Expert Group 2012)6 Such reforms could for example includeprohibiting banks from carrying out some activities such as proprietary trading (asenvisaged in the Dodd-Frank act in the US) or requiring banks to ring-fence theirdeposit-taking activities from investment banking as proposed by the IndependentBanking Commission in the UK In this case as well the jury is still out

AcknowledgementsThe author wishes to acknowledge financial support from the European Research Council (204398FINGOVEU) and the British Academy (SG 120191) This paper was written while the author wasa visiting fellow at the Max Planck Institute the European University Institute and HanseWissenschaftskolleg

Notes1 httpeuropaeurapidpressReleasesActiondoreference=MEMO12416ampfor-

mat=HTMLampaged=0amplanguage=ENampguiLanguage=en2 Sweden has a significant private equity industry hence it was seen as having a vested interest

in the revision of the text of the directive3 All these legislative texts can be found at httpeceuropaeuinternal_marketfinancescommit-

teesindex_enhtm4 httpeuropaeurapidpress-release_MEMO-12-656_enhtmlocale=en5 httpeuropaeurapidpress-release_IP-12-953_enhtmlocale=en6 httpeuropaeurapidpressReleasesActiondoreference=MEMO12129ampfor-

mat=HTMLampaged=1amplanguage=ENampguiLanguage=en]

ReferencesAktas C and Cortuk O 2012 Turkeyrsquos experience with the global crisis restructuring policies

within a financial stability framework Journal of Economic Policy Reform 15 (3) 195ndash205Baker A 2012 The new political economy of the macroprudential ideational shift New Political

Economy iFirstBasel Committee on Banking Supervision 2010a Basel III A global regulatory framework for

more resilient banks and banking systems DecemberBasel Committee on Banking Supervision 2010b Basel III International framework for liquidity

risk measurement standards and monitoring DecemberBroby D 2012 The regulatory evolution of the post credit crisis fund management industry

Journal of Economic Policy Reform 15 (1) 5ndash11Brunnermeier M Crockett A Goodhart C Persaud AD Shin HS 2009 The fundamental

principles of financial regulation Geneva Reports on the World Economy 11

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and for the individual institutions within the group Authorities can require a bank tochange its legal or operational structures to ensure that it can be resolved with the availabletools Financial groups may enter into intra-group support agreements in the form of loansor the provision of guarantees The framework envisages early supervisory interventionwhereby the authorities could require banks to implement measures set out in the recoveryplan and would have the power to appoint a special manager at a bank for a limited period

The harmonised resolution tools and powers outlined in the directive are designed toensure that national authorities in all member states have a common toolkit and roadmapto manage the failure of banks Amongst the tools considered there is the bail-in toolwhereby banks would be recapitalised with shareholders wiped out or diluted and credi-tors would have their claims reduced or converted to shares Resolution colleges are tobe established under the leadership of the group resolution authority and with the partici-pation of the European Banking Authority (EBA) The EBA will facilitate joint actionsand act as a binding mediator if necessary

The legislation envisaged the creation of resolution funding which would raise contri-butions from banks proportionate to their liabilities and risk profiles and would not beused to bail out a bank There is a link between this piece of legislation and the directiveon DGS which will provide funding for the protection of retail depositors Member stateswill be allowed to merge these two funds provided that the scheme remains in positionto repay depositors in case of failure The Commission noted that ideally a single pan-European fund should be established with a pan-European resolution authority to manageits disbursal but the absence of a single European banking supervisor and insolvencyregime would make this unworkable1 As in the case of the DGS the obstacles to thesefar-reaching changes were ultimately political as explained in Section 3 and negotiationsare ongoing

Securities markets regulation in the EU

Regulation on Credit Rating Agencies

In the securities sector Credit Rating Agencies (CRAs) were singled out amongst the mainculprits of the crisis for failing to rate properly financial products (Brunnermeier et al2009) They substantially over-rated many complex securities created through the financialactivity of securitisation and were slow in revising their ratings once market conditionsdeteriorated The over-generous rating of securities was influenced by the strong competi-tion taking place between CRAs in order to attract clients and by conflicts of interestbecause CRAs provided a variety of other services to the potential issuers requiring ratinghence they had strong incentives to be generous in their assessment of creditworthiness

Prior to the crisis CRAs were regulated internationally by a voluntary Code of Con-duct Fundamentals issued by IOSCO in 2004 and revised in the wake of the crisis in2008 The EU had considered and then ruled out specific EU rules on CRAs (Muumlgge2011) After the crisis the French presidency of the EU in the second semester of 2008implicitly made EU legislation on CRAs one of its priorities The European Council calledfor a legislative proposal to strengthen the rules on credit rating agencies and their supervi-sion at EU level in October 2008 (Quaglia 2009) Influential MEPs supported the regula-tion of CRAs in the EU The (revised) IOSCO Code provided the benchmark for theCommissionrsquos draft regulation on CRAs However the Commission argued that theIOSCO rules needed to be made more concrete and be backed by enforcement (Moschella2011 Pagliari 2011)

Journal of Economic Policy Reform 21

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The Regulation on CRAs was agreed relatively quickly by the EU in less than a yearAccording to the new rules all CRAs whose ratings are used in the EU need to applyfor registration in the EU and have to comply with rules designed to prevent conflict ofinterest in the rating process and to ensure the quality of the rating methodology and theratings CRAs operating in non-EU jurisdictions can issue ratings to be used in the EUprovided that their countries of origin have a regulatory framework recognised as equiva-lent to the one put in place by the EU or that such ratings are endorsed by an EU-regis-tered CRA (Council of Ministers and European Parliament 2009)

In June 2010 the Commission proposed an amendment of the Regulation on CRAsadopted in 2009 Since ratings issued by a CRA can be used by financial institutionsthroughout the EU the Commission proposed a more centralised system for supervisionof CRAs whereby the newly created European Securities and Markets Authority (ESMAdiscussed below) was entrusted with exclusive supervisory powers over CRAs registeredin the EU including European subsidiaries of US-headquartered CRAs such as FitchMoody and Standard amp Poor The ESMA was given powers to request information tolaunch investigations and to perform on-site inspections The amended regulation wasadopted by the Council and the EP in May 2011 (Council of Ministers and European Par-liament 2011) In the summer of 2011 the downgrading of the government bonds in thecountries directly hit by the sovereign debt crisis by the (mainly US-headquartered)CRAs gave new momentum to the debate on the creation of the European rating agencya proposal that was put forward by the EP

Alternative Investment Funds Managers Directive

The attempt to regulate hedge funds in the EU was given new momentum by the finan-cial crisis (see Broby 2012) In June 2009 the European Commission presented its pro-posal for the draft directive on AIFMs (Alternative Investment Funds Managers) whichincluded managers of hedge funds private equities funds and real estate funds hencecovering quite a broad range of financial entities The main sponsors of the directive wereFrance Germany Italy whereas the UK some Northern countries and AIFMs reluctantlyagreed to it and only after some of its most controversial provisions were watered down(see Buckley and Howarth 2010 Quaglia 2011 Woll 2012) After intense lobbying fromindustry the US and the UK the draft directive was partly revised during the Swedishpresidency2 of the EU in the second semester of 2009 An agreement between the Coun-cil of Ministers and the EP was eventually reached in late October 2010 and the direc-tive is due to enter into force in 2013

It introduces a legally binding authorisation and supervisory regime for all AIFMs inthe EU irrespective of the legal domicile of the alternative investment funds managedHence AIFMs will be subject to authorisation from the competent authority of the homemember state and to reporting requirements of systemically important data to supervisorsThe directive sets up a European passport for AIFMs Hence an AIFM authorised in itshome member state will be entitled to market its funds to professional investors in othermember states which will not be permitted to impose additional requirements (Councilof Ministers and European Parliament 2011)

European Market Infrastructure Regulation

Prior to the global financial crisis a large number of derivatives were traded over thecounter (OTC) not through stock exchanges and were not cleared through central

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counterparties (CCPs) Derivative trading on stock exchanges increases transparency andcentral counterparties reduce counterparty risk (ie the risk of default by one party to thecontract) so that the default of one market participant would not cause the collapse ofother market players thereby putting the entire financial system at risk The OTC deriva-tives comprise a wide variety of products (interest rates credit equity foreign exchangeand commodities) with different characteristics They are used in a variety of waysincluding for purposes of hedging investing and speculating OTC derivatives accountfor almost 90 of the derivatives markets The default of Lehman Brothers and thebailout of AIG highlighted the need to get more reliable information on what goes on inthe OTC derivatives market which in the past had remained outside the perimeter of reg-ulation In the past the US and the UK authorities had adamantly opposed regulatingderivatives They no longer did so after the crisis (on the EU-US regulatory relationsafter the crisis see Pagliari 2012)

In September 2010 the Commission proposed the European Market InfrastructureRegulation (EMIR (Commission 2010d)) The proposed legislation aimed to ensure thetransparency of OTC derivatives transactions and to reduce the risks associated with theseproducts by shifting where possible OTC derivatives trading to CCPs These CCPs wouldreduce counterparty risks because they act as intermediaries between sellers and buyersof derivative products They would ensure the solvency of their participants by requestingdeposits and margin calls The proposed regulation also would involve the creation ofharmonised rules for CCPs and EU supervision of trade repositories The reporting of alltransactions would be mandatory and would provide supervisory authorities with the fullpicture of these markets

EMIR was considered a critical piece of legislation by the Commission and Mem-ber States in order to meet G20 commitments at the September 2009 Pittsburgh sum-mit It was initially conceived by the Commission as a directive but it quicklychanged to become a regulation This distinction is important because as explainedabove regulations are enacted into law with immediate effect in EU member stateswith no discretion over their interpretation EMIR was driven by the Commission withsupport from Germany and France The British government was broadly in favour butopposed certain elements of the proposed legislation (see Buckley et al 2012) TheParliament and the Council agreed on their negotiating positions in July 2011 andOctober 2011 respectively Subsequently a trialogue between the Council the Parlia-ment and the Commission took place The final (Level 1) text of the regulation wasfinally agreed in March 2012 In 2012 the ESMA began drafting Level 2 rules thatsupport the Level 1 regulation

Financial supervision in the EU

The global financial crisis revealed the weaknesses of existing macro-prudential oversightin the EU and the inadequacy of nationally-based supervisory models in overseeing inte-grated financial markets with cross-border operators (Group of Thirty 2009) It exposedshortcomings in the consistent application of Community law (the lack of a Europeanrule book) as well as insufficient cooperation between supervisors in exchanging infor-mation and in crisis management In 2009 a group of high level practitioners and finan-cial experts chaired by the former governor of the Banque de France produced a reporton the issue which was named after the chair of the group (de Larosiegravere Group 2009)Building on the de Larosierersquos report in September 2009 the Commission put forward a

Journal of Economic Policy Reform 23

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series of legislative proposals for the reform of the micro- and macro-prudential frame-work for financial supervision in the EU The Commission proposals were eventuallyagreed by the Council and European Parliament in the autumn of 2010 and were imple-mented in early 20113

The main institutional innovations were the establishment of the European SystemicRisk Board its chair to be elected by and from the members of the General Council ofthe European Central Bank (ECB) and in charge of monitoring macro-prudential risk thetransformation of the so-called level three Lamfalussy committees of national regulatorsinto independent authorities with legal personality an increased budget and enhancedpowers The newly created bodies namely the European Banking Authority the Euro-pean Insurance and Occupational Pension Authority and the European Securities MarketsAuthority were charged with the tasks of coordinating the application of supervisorystandards and promoting stronger cooperation between national supervisors Moreoverindividual ESAs were given specific roles for example ESMA is the EU supervisor ofcredit rating agencies while EBA and EIOPA carry out lsquostress testsrsquo of their respectivesectors Yet the new agencies have limited competences and their effective ability toregulate the financial sector remains to be seen

In the negotiations of these institutional reforms disagreements broke out in the Coun-cil and between the Council and the EP concerning the powers of the newly createdbodies as well as the role of the EP in the proposed architecture In the Council therewere (mainly British) concerns about giving the new authorities powers over national reg-ulators and the possibility of supervising individual financial cross-border institutions(Buckley and Howarth 2010) Besides the UK Ireland and Luxemburg were also reluctantto transfer powers away from national supervisors to bodies outside their borders More-over the UK government was reluctant to grant decision-making powers to EU-levelbodies while public funds to tackle banking crises came from national budgets To thiseffect Gordon Brown the British Prime Minister secured a guarantee that the new super-visory system would not include powers to force national governments to bail out banksThat said a number of Member States particularly those with large financial centresnamely the UK France and Germany favoured the limited reform approach and were hes-itant about transferring substantive power to the EU level (Buckley and Howarth 2010)This led to a significant reduction in the scope of the Commission proposals during thenegotiations in the Council By contrast the EP argued that the Commissionrsquos proposalsdid not go far enough and was adamant about safeguarding the powers of the ESAs andenhancing its own oversight role To some extent it was successful in doing so

The Banking Union

The belated banking crisis in Spain (see Royo forthcoming) which risked wreaking thepublic finance in this country exposed the vicious circle between the sovereign debt cri-sis and the financial (meaning banking) crisis In June 2012 the European Council andEuro Area summit agreed to deepen Economic and Monetary Union creating a lsquoBankingUnionrsquo (Euroarea statement 2012) This Union was to be based on four components asingle rulebook more integrated banking supervision a pan-EU deposit guaranteescheme a common EU-wide framework for the managed resolution of banks and finan-cial institutions The Member States decided to make the set-up of a single supervisorymechanism a precondition for the possible direct recapitalisation of banks by the Euro-pean Stability Mechanism (ESM) created to deal with the sovereign debt crisis

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In September 2012 the Commission adopted a set of legislative proposals on theestablishment of a single supervisory mechanism led by the ECB The proposals con-cerned a regulation giving strong powers for the supervision of all banks in the euro areato the ECB and national supervisory authorities a regulation with limited specificchanges to the regulation setting up the European Banking Authority (EBA) to ensure abalance in its decision making structures between the euro area and non-euro area Mem-ber States a communication on a roadmap for completing the banking union over thecoming years covering the single rulebook common deposit protection and a single bankresolution mechanism4

In the new single mechanism ultimate responsibility for specific supervisory tasksrelated to the financial stability of all Euro area banks will lie with the ECB Nationalsupervisors will continue to play an important role in day-to-day supervision and in pre-paring and implementing ECB decisions The ECB will become responsible for taskssuch as authorising credit institutions compliance with capital leverage and liquidityrequirements and conducting supervision of financial conglomerates (Commission of theEuropean Communities 2012a) The ECB will be able to carry out early interventionmeasures when a bank breaches or risks breaching regulatory capital requirements byrequiring banks to take remedial action The Commission also proposed the developmentof the Single Supervisory Handbook by the European Banking Authority (EBA)

The ECB will cooperate with the EBA within the framework of the European Systemof financial supervision The role of the EBA will be similar to today it will continuedeveloping the single rulebook applicable to all 27 Member States and make sure thatsupervisory practices are consistent across the whole Union5 After agreement on thepending proposals as a next step the Commission envisages making a proposal for a sin-gle European resolution mechanism The political discussions on this reform are stillongoing

3 An overall assessment of the reforms in the EU and the main open issues

Three main features of the regulatory measures adopted or officially proposed by the EUin the wake of the crisis stand out First the reforms enacted either regulated activities orfinancial institutions that were previously unregulated in the EU and its member states(CRAs) or at the EU level (AIFMs) or at the national EU and international level(OTCDs) In other instances they imposed heavier more prescriptive and more burden-some requirements on financial entities that were already regulated prior to the crisis asin the case of higher capital requirements for banks and new liquidity management rules(Basel III) or they set in place more substantial protection for depositors (the DGSD)That said some key controversial issues discussed below were not fully addressed

Second although with some notable exceptions the new or amended rules were gen-erally resisted by the UK Ireland Luxemburg and a variable mix of Nordic countriesThe market players primarily affected by the new or revised rules such as CRAs andAIFMs initially resisted the proposed rules Subsequently they engaged in intense lobby-ing with a view to having the proposed rules amended on the grounds that they would beover-prescriptive and costly to implement creating potential regulatory arbitrage vis-agrave-viscountries outside the EU (Quaglia 2012) A somewhat special case was the new capitaland liquidity rules whereby the UK favoured new strict rules on capital requirementsand liquidity provisions whereas France Germany and Italy called for lsquosofterrsquo rules anda longer transition period

Journal of Economic Policy Reform 25

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Third the pace of reform was somewhat piecemeal in the EU This has partly to dowith the interlocking mechanisms of policy making in the EU where there are severalveto players The main agenda-setter of the reform efforts was the Commission which isthe only body that can officially propose legislation in the EU Of course the Commis-sion did so after consulting the member states informally and after holding open publicconsultations In certain cases the Commission was spurred to act by the initiatives ofthe EP as in the case of CRAs and by the continental member states as in the case ofAIFM The Council and the EP were the main decision-makers because they had thepower to adopt or amend the legislation proposed by the Commission Often the memberstates had different priorities and they were worried about potential regulatory arbitragewith jurisdictions outside the EU Lobbying from the financial industry which was keento limit the extent of regulatory change at the national EU and international levels insome cases watered down the proposed reforms but so did the political disagreementbetween the member states

Several problematic issues were highlighted by the crisis and they were only partiallyaddressed by the reforms implemented by the EU afterward The first is the disjuncturebetween globalised financial markets financial market integration in the EU EU financialregulation and national systems of supervision A vast body of international politicaleconomy literature has discussed the internationalisation or globalisation of finance fromthe 1990s onwards (see Helleiner 1994) Financial market integration in the EU substan-tially intensified after the introduction of the single currency and the completion of thesingle market in financial services envisaged by the Financial Services Action Plan in1999 EU rules to a large extent provide the framework for financial regulation in themember states However EU rules are also embedded into or coexist with internationalrules on certain activities The most notable examples are capital requirements for banksset by the Basel accords Unlike financial regulation which is mostly set at the EU levelfinancial supervision in the EU is mainly carried out at the national level by central banks(whenever they are responsible for banking supervision) or the banking supervisoryauthorities if separated from the central bank and the supervisors of other financial activ-ities (eg securities markets)

This fragmentation of powers and responsibilities severely constrains the publicauthoritiesrsquo ability to supervise financial markets and financial entities active in theirjurisdictions This is particularly problematic in the case of ailing cross-border financialinstitutions whereby the key issue is burden sharing that isrsquo the distribution of costsbetween the home and host countries and across the host jurisdictions in which cross-bor-der financial institutions operate (see Dyson and Quaglia 2010) Furthermore sometimesfinancial institutions are too big to be rescued by their home countries ultimately by thetreasury and taxpayers of the country in which they are headquartered This was the caseof the Icelandic banks operating cross-border in the EU This is a challenge not only forthe small countries but also for the large ones that are home countries of very big finan-cial entities For example the Deutsche Bank balance sheet amount to a significant shareof German GDP

Moreover the banking system of several central and eastern European countries is lar-gely foreign owned This raises three main concerns First there are banks that are ofsystemic importance in the new member states but not in the country in which they areheadquartered Second host supervisors can exert only limited control on foreign banksoperating in their jurisdictions particularly when they take the legal form of branchesThis point was stressed in the Turner report 2010 (Financial Services Authority 2009)which went as far as suggesting the compulsory transformation of branches into

26 L Quaglia

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subsidiaries under specific circumstances In the case of subsidiaries which are separatelegal entities in the countries in which they operate key functions might well be centra-lised within the financial groups of which such subsidiaries are part de facto limiting thepower of the host country supervisors Thirdly there is the risk that as a consequence ofthe financial turmoil such banks might retreat (ie pull out funding) abruptly from thehost countries

The bank resolution regime proposed by the Commission in June 2012 after years ofpreparation and several rounds of public consultations does not fully address these short-comings Nor does the DGS directive Ultimately there is an inescapable link betweenfinancial supervision crisis management and resolution and fiscal power (that is theability to use taxpayer money to deal with ailing banks) Fiscal policy goes to the core ofnational sovereignty which explains the reluctance of member states to the creation ofpan-European institutions (be they DGS funds resolution funds or resolution authorities)in this field Moreover the costs and the benefits ensuing from the establishment of theseinstitutions are likely to be unequally distributed across the member states In the endcountries with sound banking systems will have to foot the bill of crisis resolution incountries with less stable banking systems All this raises the problem of the under provi-sion of the public good of financial stability meaning that everybody benefits from finan-cial stability but the costs of providing this public good tend to be specific

Second the global financial crisis brought into sharp relief the interconnection betweenmonetary policy macroeconomic imbalances and financial stability in particular theeffects that the former can have on the latter (see Aktas and Cortuk 2012) Several authorshave pointed out the effects of macroeconomic imbalances such as the permanent deficitsin the US balance of payments (Pauly 2009) and of relatively accommodating monetarypolicies in the US but also to some extent in the EU (Carmassi et al 2009) in fuelling theglobal financial crisis Moreover deficits in the balance of payments are generally accom-panied by fiscal imbalances in particular in Southern Europe where the sovereign debtcrisis followed the financial crisis In turn the sovereign debt crisis risked turning into abanking crisis showing the interconnection between the two types of crises (for a discus-sion of several interesting country studies see Hardie and Howarth forthcoming)

In some countries such as Ireland it was the financial crisis and ultimately the statersquosrescue of the banking system that substantially worsened the public finances (public defi-cit and debt) triggering the sovereign debt crisis In other countries such as Italy andGreece the sovereign debt crisis had domestic origins it was rooted in a loose fiscal pol-icy while the national banking sector was relatively sound and only marginally affectedby the financial (banking) crisis However once the Greek and Italian state faced defaulttheir banking systems were penalised and the sovereign debt crisis risked turning into abanking crisis The problems experienced by some Spanish banks gave new momentumto the idea of a banking union discussed above highlighting the vicious circle betweenbanks and sovereigns Especially in the case of the sovereign debt crisis some commen-tators have argued that the EU and in particular the European Commission is reactive notproactive For example the Nobel-laureate US economist Paul Krugman pointed outthe need for lsquoa Marshall plan for Europersquo (The Guardian 22 January 2012 see alsoKrugman 2012ab)

Conclusions

This article has examined the regulatory response of the EU to the financial crisis endingwith a concise discussion of the link between the financial crisis and the sovereign debt

Journal of Economic Policy Reform 27

Dow

nloa

ded

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il 20

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crisis Set against the benchmarks outlined in the introduction it is possible to concludethat despite the new pieces of legislation adopted by the EU the framework for financialservices regulation and supervision in the EU is not substantially different from the pre-crisis one The main obstacles to more far-reaching reform were political not economic

The EU is generally a slow moving institution and tends to be reactive rather thanproactive It took the Commission more than three years and several rounds of consulta-tion to come forward with a formal legislative proposal for a banking resolution regimeNegotiations in the Council and EP have just started and are likely to be time consumingThe DGS directive officially proposed by the Commission in 2010 has not yet beenagreed The proposed Banking Union would represent quite a major reform Yet it is farfrom being agreed and political discussions are ongoing

The Commission is also trying to grapple with structural issues concerning the bank-ing sector in the EU In February 2012 it appointed a High-level Expert Group headedby Erkki Liikanen (former governor of the central bank of Finland) to examine structuralreforms that would directly affect the structure of individual banks and the market as awhole (High Level Expert Group 2012)6 Such reforms could for example includeprohibiting banks from carrying out some activities such as proprietary trading (asenvisaged in the Dodd-Frank act in the US) or requiring banks to ring-fence theirdeposit-taking activities from investment banking as proposed by the IndependentBanking Commission in the UK In this case as well the jury is still out

AcknowledgementsThe author wishes to acknowledge financial support from the European Research Council (204398FINGOVEU) and the British Academy (SG 120191) This paper was written while the author wasa visiting fellow at the Max Planck Institute the European University Institute and HanseWissenschaftskolleg

Notes1 httpeuropaeurapidpressReleasesActiondoreference=MEMO12416ampfor-

mat=HTMLampaged=0amplanguage=ENampguiLanguage=en2 Sweden has a significant private equity industry hence it was seen as having a vested interest

in the revision of the text of the directive3 All these legislative texts can be found at httpeceuropaeuinternal_marketfinancescommit-

teesindex_enhtm4 httpeuropaeurapidpress-release_MEMO-12-656_enhtmlocale=en5 httpeuropaeurapidpress-release_IP-12-953_enhtmlocale=en6 httpeuropaeurapidpressReleasesActiondoreference=MEMO12129ampfor-

mat=HTMLampaged=1amplanguage=ENampguiLanguage=en]

ReferencesAktas C and Cortuk O 2012 Turkeyrsquos experience with the global crisis restructuring policies

within a financial stability framework Journal of Economic Policy Reform 15 (3) 195ndash205Baker A 2012 The new political economy of the macroprudential ideational shift New Political

Economy iFirstBasel Committee on Banking Supervision 2010a Basel III A global regulatory framework for

more resilient banks and banking systems DecemberBasel Committee on Banking Supervision 2010b Basel III International framework for liquidity

risk measurement standards and monitoring DecemberBroby D 2012 The regulatory evolution of the post credit crisis fund management industry

Journal of Economic Policy Reform 15 (1) 5ndash11Brunnermeier M Crockett A Goodhart C Persaud AD Shin HS 2009 The fundamental

principles of financial regulation Geneva Reports on the World Economy 11

28 L Quaglia

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Apr

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13

The Regulation on CRAs was agreed relatively quickly by the EU in less than a yearAccording to the new rules all CRAs whose ratings are used in the EU need to applyfor registration in the EU and have to comply with rules designed to prevent conflict ofinterest in the rating process and to ensure the quality of the rating methodology and theratings CRAs operating in non-EU jurisdictions can issue ratings to be used in the EUprovided that their countries of origin have a regulatory framework recognised as equiva-lent to the one put in place by the EU or that such ratings are endorsed by an EU-regis-tered CRA (Council of Ministers and European Parliament 2009)

In June 2010 the Commission proposed an amendment of the Regulation on CRAsadopted in 2009 Since ratings issued by a CRA can be used by financial institutionsthroughout the EU the Commission proposed a more centralised system for supervisionof CRAs whereby the newly created European Securities and Markets Authority (ESMAdiscussed below) was entrusted with exclusive supervisory powers over CRAs registeredin the EU including European subsidiaries of US-headquartered CRAs such as FitchMoody and Standard amp Poor The ESMA was given powers to request information tolaunch investigations and to perform on-site inspections The amended regulation wasadopted by the Council and the EP in May 2011 (Council of Ministers and European Par-liament 2011) In the summer of 2011 the downgrading of the government bonds in thecountries directly hit by the sovereign debt crisis by the (mainly US-headquartered)CRAs gave new momentum to the debate on the creation of the European rating agencya proposal that was put forward by the EP

Alternative Investment Funds Managers Directive

The attempt to regulate hedge funds in the EU was given new momentum by the finan-cial crisis (see Broby 2012) In June 2009 the European Commission presented its pro-posal for the draft directive on AIFMs (Alternative Investment Funds Managers) whichincluded managers of hedge funds private equities funds and real estate funds hencecovering quite a broad range of financial entities The main sponsors of the directive wereFrance Germany Italy whereas the UK some Northern countries and AIFMs reluctantlyagreed to it and only after some of its most controversial provisions were watered down(see Buckley and Howarth 2010 Quaglia 2011 Woll 2012) After intense lobbying fromindustry the US and the UK the draft directive was partly revised during the Swedishpresidency2 of the EU in the second semester of 2009 An agreement between the Coun-cil of Ministers and the EP was eventually reached in late October 2010 and the direc-tive is due to enter into force in 2013

It introduces a legally binding authorisation and supervisory regime for all AIFMs inthe EU irrespective of the legal domicile of the alternative investment funds managedHence AIFMs will be subject to authorisation from the competent authority of the homemember state and to reporting requirements of systemically important data to supervisorsThe directive sets up a European passport for AIFMs Hence an AIFM authorised in itshome member state will be entitled to market its funds to professional investors in othermember states which will not be permitted to impose additional requirements (Councilof Ministers and European Parliament 2011)

European Market Infrastructure Regulation

Prior to the global financial crisis a large number of derivatives were traded over thecounter (OTC) not through stock exchanges and were not cleared through central

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counterparties (CCPs) Derivative trading on stock exchanges increases transparency andcentral counterparties reduce counterparty risk (ie the risk of default by one party to thecontract) so that the default of one market participant would not cause the collapse ofother market players thereby putting the entire financial system at risk The OTC deriva-tives comprise a wide variety of products (interest rates credit equity foreign exchangeand commodities) with different characteristics They are used in a variety of waysincluding for purposes of hedging investing and speculating OTC derivatives accountfor almost 90 of the derivatives markets The default of Lehman Brothers and thebailout of AIG highlighted the need to get more reliable information on what goes on inthe OTC derivatives market which in the past had remained outside the perimeter of reg-ulation In the past the US and the UK authorities had adamantly opposed regulatingderivatives They no longer did so after the crisis (on the EU-US regulatory relationsafter the crisis see Pagliari 2012)

In September 2010 the Commission proposed the European Market InfrastructureRegulation (EMIR (Commission 2010d)) The proposed legislation aimed to ensure thetransparency of OTC derivatives transactions and to reduce the risks associated with theseproducts by shifting where possible OTC derivatives trading to CCPs These CCPs wouldreduce counterparty risks because they act as intermediaries between sellers and buyersof derivative products They would ensure the solvency of their participants by requestingdeposits and margin calls The proposed regulation also would involve the creation ofharmonised rules for CCPs and EU supervision of trade repositories The reporting of alltransactions would be mandatory and would provide supervisory authorities with the fullpicture of these markets

EMIR was considered a critical piece of legislation by the Commission and Mem-ber States in order to meet G20 commitments at the September 2009 Pittsburgh sum-mit It was initially conceived by the Commission as a directive but it quicklychanged to become a regulation This distinction is important because as explainedabove regulations are enacted into law with immediate effect in EU member stateswith no discretion over their interpretation EMIR was driven by the Commission withsupport from Germany and France The British government was broadly in favour butopposed certain elements of the proposed legislation (see Buckley et al 2012) TheParliament and the Council agreed on their negotiating positions in July 2011 andOctober 2011 respectively Subsequently a trialogue between the Council the Parlia-ment and the Commission took place The final (Level 1) text of the regulation wasfinally agreed in March 2012 In 2012 the ESMA began drafting Level 2 rules thatsupport the Level 1 regulation

Financial supervision in the EU

The global financial crisis revealed the weaknesses of existing macro-prudential oversightin the EU and the inadequacy of nationally-based supervisory models in overseeing inte-grated financial markets with cross-border operators (Group of Thirty 2009) It exposedshortcomings in the consistent application of Community law (the lack of a Europeanrule book) as well as insufficient cooperation between supervisors in exchanging infor-mation and in crisis management In 2009 a group of high level practitioners and finan-cial experts chaired by the former governor of the Banque de France produced a reporton the issue which was named after the chair of the group (de Larosiegravere Group 2009)Building on the de Larosierersquos report in September 2009 the Commission put forward a

Journal of Economic Policy Reform 23

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series of legislative proposals for the reform of the micro- and macro-prudential frame-work for financial supervision in the EU The Commission proposals were eventuallyagreed by the Council and European Parliament in the autumn of 2010 and were imple-mented in early 20113

The main institutional innovations were the establishment of the European SystemicRisk Board its chair to be elected by and from the members of the General Council ofthe European Central Bank (ECB) and in charge of monitoring macro-prudential risk thetransformation of the so-called level three Lamfalussy committees of national regulatorsinto independent authorities with legal personality an increased budget and enhancedpowers The newly created bodies namely the European Banking Authority the Euro-pean Insurance and Occupational Pension Authority and the European Securities MarketsAuthority were charged with the tasks of coordinating the application of supervisorystandards and promoting stronger cooperation between national supervisors Moreoverindividual ESAs were given specific roles for example ESMA is the EU supervisor ofcredit rating agencies while EBA and EIOPA carry out lsquostress testsrsquo of their respectivesectors Yet the new agencies have limited competences and their effective ability toregulate the financial sector remains to be seen

In the negotiations of these institutional reforms disagreements broke out in the Coun-cil and between the Council and the EP concerning the powers of the newly createdbodies as well as the role of the EP in the proposed architecture In the Council therewere (mainly British) concerns about giving the new authorities powers over national reg-ulators and the possibility of supervising individual financial cross-border institutions(Buckley and Howarth 2010) Besides the UK Ireland and Luxemburg were also reluctantto transfer powers away from national supervisors to bodies outside their borders More-over the UK government was reluctant to grant decision-making powers to EU-levelbodies while public funds to tackle banking crises came from national budgets To thiseffect Gordon Brown the British Prime Minister secured a guarantee that the new super-visory system would not include powers to force national governments to bail out banksThat said a number of Member States particularly those with large financial centresnamely the UK France and Germany favoured the limited reform approach and were hes-itant about transferring substantive power to the EU level (Buckley and Howarth 2010)This led to a significant reduction in the scope of the Commission proposals during thenegotiations in the Council By contrast the EP argued that the Commissionrsquos proposalsdid not go far enough and was adamant about safeguarding the powers of the ESAs andenhancing its own oversight role To some extent it was successful in doing so

The Banking Union

The belated banking crisis in Spain (see Royo forthcoming) which risked wreaking thepublic finance in this country exposed the vicious circle between the sovereign debt cri-sis and the financial (meaning banking) crisis In June 2012 the European Council andEuro Area summit agreed to deepen Economic and Monetary Union creating a lsquoBankingUnionrsquo (Euroarea statement 2012) This Union was to be based on four components asingle rulebook more integrated banking supervision a pan-EU deposit guaranteescheme a common EU-wide framework for the managed resolution of banks and finan-cial institutions The Member States decided to make the set-up of a single supervisorymechanism a precondition for the possible direct recapitalisation of banks by the Euro-pean Stability Mechanism (ESM) created to deal with the sovereign debt crisis

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In September 2012 the Commission adopted a set of legislative proposals on theestablishment of a single supervisory mechanism led by the ECB The proposals con-cerned a regulation giving strong powers for the supervision of all banks in the euro areato the ECB and national supervisory authorities a regulation with limited specificchanges to the regulation setting up the European Banking Authority (EBA) to ensure abalance in its decision making structures between the euro area and non-euro area Mem-ber States a communication on a roadmap for completing the banking union over thecoming years covering the single rulebook common deposit protection and a single bankresolution mechanism4

In the new single mechanism ultimate responsibility for specific supervisory tasksrelated to the financial stability of all Euro area banks will lie with the ECB Nationalsupervisors will continue to play an important role in day-to-day supervision and in pre-paring and implementing ECB decisions The ECB will become responsible for taskssuch as authorising credit institutions compliance with capital leverage and liquidityrequirements and conducting supervision of financial conglomerates (Commission of theEuropean Communities 2012a) The ECB will be able to carry out early interventionmeasures when a bank breaches or risks breaching regulatory capital requirements byrequiring banks to take remedial action The Commission also proposed the developmentof the Single Supervisory Handbook by the European Banking Authority (EBA)

The ECB will cooperate with the EBA within the framework of the European Systemof financial supervision The role of the EBA will be similar to today it will continuedeveloping the single rulebook applicable to all 27 Member States and make sure thatsupervisory practices are consistent across the whole Union5 After agreement on thepending proposals as a next step the Commission envisages making a proposal for a sin-gle European resolution mechanism The political discussions on this reform are stillongoing

3 An overall assessment of the reforms in the EU and the main open issues

Three main features of the regulatory measures adopted or officially proposed by the EUin the wake of the crisis stand out First the reforms enacted either regulated activities orfinancial institutions that were previously unregulated in the EU and its member states(CRAs) or at the EU level (AIFMs) or at the national EU and international level(OTCDs) In other instances they imposed heavier more prescriptive and more burden-some requirements on financial entities that were already regulated prior to the crisis asin the case of higher capital requirements for banks and new liquidity management rules(Basel III) or they set in place more substantial protection for depositors (the DGSD)That said some key controversial issues discussed below were not fully addressed

Second although with some notable exceptions the new or amended rules were gen-erally resisted by the UK Ireland Luxemburg and a variable mix of Nordic countriesThe market players primarily affected by the new or revised rules such as CRAs andAIFMs initially resisted the proposed rules Subsequently they engaged in intense lobby-ing with a view to having the proposed rules amended on the grounds that they would beover-prescriptive and costly to implement creating potential regulatory arbitrage vis-agrave-viscountries outside the EU (Quaglia 2012) A somewhat special case was the new capitaland liquidity rules whereby the UK favoured new strict rules on capital requirementsand liquidity provisions whereas France Germany and Italy called for lsquosofterrsquo rules anda longer transition period

Journal of Economic Policy Reform 25

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Third the pace of reform was somewhat piecemeal in the EU This has partly to dowith the interlocking mechanisms of policy making in the EU where there are severalveto players The main agenda-setter of the reform efforts was the Commission which isthe only body that can officially propose legislation in the EU Of course the Commis-sion did so after consulting the member states informally and after holding open publicconsultations In certain cases the Commission was spurred to act by the initiatives ofthe EP as in the case of CRAs and by the continental member states as in the case ofAIFM The Council and the EP were the main decision-makers because they had thepower to adopt or amend the legislation proposed by the Commission Often the memberstates had different priorities and they were worried about potential regulatory arbitragewith jurisdictions outside the EU Lobbying from the financial industry which was keento limit the extent of regulatory change at the national EU and international levels insome cases watered down the proposed reforms but so did the political disagreementbetween the member states

Several problematic issues were highlighted by the crisis and they were only partiallyaddressed by the reforms implemented by the EU afterward The first is the disjuncturebetween globalised financial markets financial market integration in the EU EU financialregulation and national systems of supervision A vast body of international politicaleconomy literature has discussed the internationalisation or globalisation of finance fromthe 1990s onwards (see Helleiner 1994) Financial market integration in the EU substan-tially intensified after the introduction of the single currency and the completion of thesingle market in financial services envisaged by the Financial Services Action Plan in1999 EU rules to a large extent provide the framework for financial regulation in themember states However EU rules are also embedded into or coexist with internationalrules on certain activities The most notable examples are capital requirements for banksset by the Basel accords Unlike financial regulation which is mostly set at the EU levelfinancial supervision in the EU is mainly carried out at the national level by central banks(whenever they are responsible for banking supervision) or the banking supervisoryauthorities if separated from the central bank and the supervisors of other financial activ-ities (eg securities markets)

This fragmentation of powers and responsibilities severely constrains the publicauthoritiesrsquo ability to supervise financial markets and financial entities active in theirjurisdictions This is particularly problematic in the case of ailing cross-border financialinstitutions whereby the key issue is burden sharing that isrsquo the distribution of costsbetween the home and host countries and across the host jurisdictions in which cross-bor-der financial institutions operate (see Dyson and Quaglia 2010) Furthermore sometimesfinancial institutions are too big to be rescued by their home countries ultimately by thetreasury and taxpayers of the country in which they are headquartered This was the caseof the Icelandic banks operating cross-border in the EU This is a challenge not only forthe small countries but also for the large ones that are home countries of very big finan-cial entities For example the Deutsche Bank balance sheet amount to a significant shareof German GDP

Moreover the banking system of several central and eastern European countries is lar-gely foreign owned This raises three main concerns First there are banks that are ofsystemic importance in the new member states but not in the country in which they areheadquartered Second host supervisors can exert only limited control on foreign banksoperating in their jurisdictions particularly when they take the legal form of branchesThis point was stressed in the Turner report 2010 (Financial Services Authority 2009)which went as far as suggesting the compulsory transformation of branches into

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subsidiaries under specific circumstances In the case of subsidiaries which are separatelegal entities in the countries in which they operate key functions might well be centra-lised within the financial groups of which such subsidiaries are part de facto limiting thepower of the host country supervisors Thirdly there is the risk that as a consequence ofthe financial turmoil such banks might retreat (ie pull out funding) abruptly from thehost countries

The bank resolution regime proposed by the Commission in June 2012 after years ofpreparation and several rounds of public consultations does not fully address these short-comings Nor does the DGS directive Ultimately there is an inescapable link betweenfinancial supervision crisis management and resolution and fiscal power (that is theability to use taxpayer money to deal with ailing banks) Fiscal policy goes to the core ofnational sovereignty which explains the reluctance of member states to the creation ofpan-European institutions (be they DGS funds resolution funds or resolution authorities)in this field Moreover the costs and the benefits ensuing from the establishment of theseinstitutions are likely to be unequally distributed across the member states In the endcountries with sound banking systems will have to foot the bill of crisis resolution incountries with less stable banking systems All this raises the problem of the under provi-sion of the public good of financial stability meaning that everybody benefits from finan-cial stability but the costs of providing this public good tend to be specific

Second the global financial crisis brought into sharp relief the interconnection betweenmonetary policy macroeconomic imbalances and financial stability in particular theeffects that the former can have on the latter (see Aktas and Cortuk 2012) Several authorshave pointed out the effects of macroeconomic imbalances such as the permanent deficitsin the US balance of payments (Pauly 2009) and of relatively accommodating monetarypolicies in the US but also to some extent in the EU (Carmassi et al 2009) in fuelling theglobal financial crisis Moreover deficits in the balance of payments are generally accom-panied by fiscal imbalances in particular in Southern Europe where the sovereign debtcrisis followed the financial crisis In turn the sovereign debt crisis risked turning into abanking crisis showing the interconnection between the two types of crises (for a discus-sion of several interesting country studies see Hardie and Howarth forthcoming)

In some countries such as Ireland it was the financial crisis and ultimately the statersquosrescue of the banking system that substantially worsened the public finances (public defi-cit and debt) triggering the sovereign debt crisis In other countries such as Italy andGreece the sovereign debt crisis had domestic origins it was rooted in a loose fiscal pol-icy while the national banking sector was relatively sound and only marginally affectedby the financial (banking) crisis However once the Greek and Italian state faced defaulttheir banking systems were penalised and the sovereign debt crisis risked turning into abanking crisis The problems experienced by some Spanish banks gave new momentumto the idea of a banking union discussed above highlighting the vicious circle betweenbanks and sovereigns Especially in the case of the sovereign debt crisis some commen-tators have argued that the EU and in particular the European Commission is reactive notproactive For example the Nobel-laureate US economist Paul Krugman pointed outthe need for lsquoa Marshall plan for Europersquo (The Guardian 22 January 2012 see alsoKrugman 2012ab)

Conclusions

This article has examined the regulatory response of the EU to the financial crisis endingwith a concise discussion of the link between the financial crisis and the sovereign debt

Journal of Economic Policy Reform 27

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crisis Set against the benchmarks outlined in the introduction it is possible to concludethat despite the new pieces of legislation adopted by the EU the framework for financialservices regulation and supervision in the EU is not substantially different from the pre-crisis one The main obstacles to more far-reaching reform were political not economic

The EU is generally a slow moving institution and tends to be reactive rather thanproactive It took the Commission more than three years and several rounds of consulta-tion to come forward with a formal legislative proposal for a banking resolution regimeNegotiations in the Council and EP have just started and are likely to be time consumingThe DGS directive officially proposed by the Commission in 2010 has not yet beenagreed The proposed Banking Union would represent quite a major reform Yet it is farfrom being agreed and political discussions are ongoing

The Commission is also trying to grapple with structural issues concerning the bank-ing sector in the EU In February 2012 it appointed a High-level Expert Group headedby Erkki Liikanen (former governor of the central bank of Finland) to examine structuralreforms that would directly affect the structure of individual banks and the market as awhole (High Level Expert Group 2012)6 Such reforms could for example includeprohibiting banks from carrying out some activities such as proprietary trading (asenvisaged in the Dodd-Frank act in the US) or requiring banks to ring-fence theirdeposit-taking activities from investment banking as proposed by the IndependentBanking Commission in the UK In this case as well the jury is still out

AcknowledgementsThe author wishes to acknowledge financial support from the European Research Council (204398FINGOVEU) and the British Academy (SG 120191) This paper was written while the author wasa visiting fellow at the Max Planck Institute the European University Institute and HanseWissenschaftskolleg

Notes1 httpeuropaeurapidpressReleasesActiondoreference=MEMO12416ampfor-

mat=HTMLampaged=0amplanguage=ENampguiLanguage=en2 Sweden has a significant private equity industry hence it was seen as having a vested interest

in the revision of the text of the directive3 All these legislative texts can be found at httpeceuropaeuinternal_marketfinancescommit-

teesindex_enhtm4 httpeuropaeurapidpress-release_MEMO-12-656_enhtmlocale=en5 httpeuropaeurapidpress-release_IP-12-953_enhtmlocale=en6 httpeuropaeurapidpressReleasesActiondoreference=MEMO12129ampfor-

mat=HTMLampaged=1amplanguage=ENampguiLanguage=en]

ReferencesAktas C and Cortuk O 2012 Turkeyrsquos experience with the global crisis restructuring policies

within a financial stability framework Journal of Economic Policy Reform 15 (3) 195ndash205Baker A 2012 The new political economy of the macroprudential ideational shift New Political

Economy iFirstBasel Committee on Banking Supervision 2010a Basel III A global regulatory framework for

more resilient banks and banking systems DecemberBasel Committee on Banking Supervision 2010b Basel III International framework for liquidity

risk measurement standards and monitoring DecemberBroby D 2012 The regulatory evolution of the post credit crisis fund management industry

Journal of Economic Policy Reform 15 (1) 5ndash11Brunnermeier M Crockett A Goodhart C Persaud AD Shin HS 2009 The fundamental

principles of financial regulation Geneva Reports on the World Economy 11

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counterparties (CCPs) Derivative trading on stock exchanges increases transparency andcentral counterparties reduce counterparty risk (ie the risk of default by one party to thecontract) so that the default of one market participant would not cause the collapse ofother market players thereby putting the entire financial system at risk The OTC deriva-tives comprise a wide variety of products (interest rates credit equity foreign exchangeand commodities) with different characteristics They are used in a variety of waysincluding for purposes of hedging investing and speculating OTC derivatives accountfor almost 90 of the derivatives markets The default of Lehman Brothers and thebailout of AIG highlighted the need to get more reliable information on what goes on inthe OTC derivatives market which in the past had remained outside the perimeter of reg-ulation In the past the US and the UK authorities had adamantly opposed regulatingderivatives They no longer did so after the crisis (on the EU-US regulatory relationsafter the crisis see Pagliari 2012)

In September 2010 the Commission proposed the European Market InfrastructureRegulation (EMIR (Commission 2010d)) The proposed legislation aimed to ensure thetransparency of OTC derivatives transactions and to reduce the risks associated with theseproducts by shifting where possible OTC derivatives trading to CCPs These CCPs wouldreduce counterparty risks because they act as intermediaries between sellers and buyersof derivative products They would ensure the solvency of their participants by requestingdeposits and margin calls The proposed regulation also would involve the creation ofharmonised rules for CCPs and EU supervision of trade repositories The reporting of alltransactions would be mandatory and would provide supervisory authorities with the fullpicture of these markets

EMIR was considered a critical piece of legislation by the Commission and Mem-ber States in order to meet G20 commitments at the September 2009 Pittsburgh sum-mit It was initially conceived by the Commission as a directive but it quicklychanged to become a regulation This distinction is important because as explainedabove regulations are enacted into law with immediate effect in EU member stateswith no discretion over their interpretation EMIR was driven by the Commission withsupport from Germany and France The British government was broadly in favour butopposed certain elements of the proposed legislation (see Buckley et al 2012) TheParliament and the Council agreed on their negotiating positions in July 2011 andOctober 2011 respectively Subsequently a trialogue between the Council the Parlia-ment and the Commission took place The final (Level 1) text of the regulation wasfinally agreed in March 2012 In 2012 the ESMA began drafting Level 2 rules thatsupport the Level 1 regulation

Financial supervision in the EU

The global financial crisis revealed the weaknesses of existing macro-prudential oversightin the EU and the inadequacy of nationally-based supervisory models in overseeing inte-grated financial markets with cross-border operators (Group of Thirty 2009) It exposedshortcomings in the consistent application of Community law (the lack of a Europeanrule book) as well as insufficient cooperation between supervisors in exchanging infor-mation and in crisis management In 2009 a group of high level practitioners and finan-cial experts chaired by the former governor of the Banque de France produced a reporton the issue which was named after the chair of the group (de Larosiegravere Group 2009)Building on the de Larosierersquos report in September 2009 the Commission put forward a

Journal of Economic Policy Reform 23

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

series of legislative proposals for the reform of the micro- and macro-prudential frame-work for financial supervision in the EU The Commission proposals were eventuallyagreed by the Council and European Parliament in the autumn of 2010 and were imple-mented in early 20113

The main institutional innovations were the establishment of the European SystemicRisk Board its chair to be elected by and from the members of the General Council ofthe European Central Bank (ECB) and in charge of monitoring macro-prudential risk thetransformation of the so-called level three Lamfalussy committees of national regulatorsinto independent authorities with legal personality an increased budget and enhancedpowers The newly created bodies namely the European Banking Authority the Euro-pean Insurance and Occupational Pension Authority and the European Securities MarketsAuthority were charged with the tasks of coordinating the application of supervisorystandards and promoting stronger cooperation between national supervisors Moreoverindividual ESAs were given specific roles for example ESMA is the EU supervisor ofcredit rating agencies while EBA and EIOPA carry out lsquostress testsrsquo of their respectivesectors Yet the new agencies have limited competences and their effective ability toregulate the financial sector remains to be seen

In the negotiations of these institutional reforms disagreements broke out in the Coun-cil and between the Council and the EP concerning the powers of the newly createdbodies as well as the role of the EP in the proposed architecture In the Council therewere (mainly British) concerns about giving the new authorities powers over national reg-ulators and the possibility of supervising individual financial cross-border institutions(Buckley and Howarth 2010) Besides the UK Ireland and Luxemburg were also reluctantto transfer powers away from national supervisors to bodies outside their borders More-over the UK government was reluctant to grant decision-making powers to EU-levelbodies while public funds to tackle banking crises came from national budgets To thiseffect Gordon Brown the British Prime Minister secured a guarantee that the new super-visory system would not include powers to force national governments to bail out banksThat said a number of Member States particularly those with large financial centresnamely the UK France and Germany favoured the limited reform approach and were hes-itant about transferring substantive power to the EU level (Buckley and Howarth 2010)This led to a significant reduction in the scope of the Commission proposals during thenegotiations in the Council By contrast the EP argued that the Commissionrsquos proposalsdid not go far enough and was adamant about safeguarding the powers of the ESAs andenhancing its own oversight role To some extent it was successful in doing so

The Banking Union

The belated banking crisis in Spain (see Royo forthcoming) which risked wreaking thepublic finance in this country exposed the vicious circle between the sovereign debt cri-sis and the financial (meaning banking) crisis In June 2012 the European Council andEuro Area summit agreed to deepen Economic and Monetary Union creating a lsquoBankingUnionrsquo (Euroarea statement 2012) This Union was to be based on four components asingle rulebook more integrated banking supervision a pan-EU deposit guaranteescheme a common EU-wide framework for the managed resolution of banks and finan-cial institutions The Member States decided to make the set-up of a single supervisorymechanism a precondition for the possible direct recapitalisation of banks by the Euro-pean Stability Mechanism (ESM) created to deal with the sovereign debt crisis

24 L Quaglia

Dow

nloa

ded

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Uni

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ST]

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950

14

Apr

il 20

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In September 2012 the Commission adopted a set of legislative proposals on theestablishment of a single supervisory mechanism led by the ECB The proposals con-cerned a regulation giving strong powers for the supervision of all banks in the euro areato the ECB and national supervisory authorities a regulation with limited specificchanges to the regulation setting up the European Banking Authority (EBA) to ensure abalance in its decision making structures between the euro area and non-euro area Mem-ber States a communication on a roadmap for completing the banking union over thecoming years covering the single rulebook common deposit protection and a single bankresolution mechanism4

In the new single mechanism ultimate responsibility for specific supervisory tasksrelated to the financial stability of all Euro area banks will lie with the ECB Nationalsupervisors will continue to play an important role in day-to-day supervision and in pre-paring and implementing ECB decisions The ECB will become responsible for taskssuch as authorising credit institutions compliance with capital leverage and liquidityrequirements and conducting supervision of financial conglomerates (Commission of theEuropean Communities 2012a) The ECB will be able to carry out early interventionmeasures when a bank breaches or risks breaching regulatory capital requirements byrequiring banks to take remedial action The Commission also proposed the developmentof the Single Supervisory Handbook by the European Banking Authority (EBA)

The ECB will cooperate with the EBA within the framework of the European Systemof financial supervision The role of the EBA will be similar to today it will continuedeveloping the single rulebook applicable to all 27 Member States and make sure thatsupervisory practices are consistent across the whole Union5 After agreement on thepending proposals as a next step the Commission envisages making a proposal for a sin-gle European resolution mechanism The political discussions on this reform are stillongoing

3 An overall assessment of the reforms in the EU and the main open issues

Three main features of the regulatory measures adopted or officially proposed by the EUin the wake of the crisis stand out First the reforms enacted either regulated activities orfinancial institutions that were previously unregulated in the EU and its member states(CRAs) or at the EU level (AIFMs) or at the national EU and international level(OTCDs) In other instances they imposed heavier more prescriptive and more burden-some requirements on financial entities that were already regulated prior to the crisis asin the case of higher capital requirements for banks and new liquidity management rules(Basel III) or they set in place more substantial protection for depositors (the DGSD)That said some key controversial issues discussed below were not fully addressed

Second although with some notable exceptions the new or amended rules were gen-erally resisted by the UK Ireland Luxemburg and a variable mix of Nordic countriesThe market players primarily affected by the new or revised rules such as CRAs andAIFMs initially resisted the proposed rules Subsequently they engaged in intense lobby-ing with a view to having the proposed rules amended on the grounds that they would beover-prescriptive and costly to implement creating potential regulatory arbitrage vis-agrave-viscountries outside the EU (Quaglia 2012) A somewhat special case was the new capitaland liquidity rules whereby the UK favoured new strict rules on capital requirementsand liquidity provisions whereas France Germany and Italy called for lsquosofterrsquo rules anda longer transition period

Journal of Economic Policy Reform 25

Dow

nloa

ded

by [

Bra

ndon

Uni

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ity G

ST]

at 0

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14

Apr

il 20

13

Third the pace of reform was somewhat piecemeal in the EU This has partly to dowith the interlocking mechanisms of policy making in the EU where there are severalveto players The main agenda-setter of the reform efforts was the Commission which isthe only body that can officially propose legislation in the EU Of course the Commis-sion did so after consulting the member states informally and after holding open publicconsultations In certain cases the Commission was spurred to act by the initiatives ofthe EP as in the case of CRAs and by the continental member states as in the case ofAIFM The Council and the EP were the main decision-makers because they had thepower to adopt or amend the legislation proposed by the Commission Often the memberstates had different priorities and they were worried about potential regulatory arbitragewith jurisdictions outside the EU Lobbying from the financial industry which was keento limit the extent of regulatory change at the national EU and international levels insome cases watered down the proposed reforms but so did the political disagreementbetween the member states

Several problematic issues were highlighted by the crisis and they were only partiallyaddressed by the reforms implemented by the EU afterward The first is the disjuncturebetween globalised financial markets financial market integration in the EU EU financialregulation and national systems of supervision A vast body of international politicaleconomy literature has discussed the internationalisation or globalisation of finance fromthe 1990s onwards (see Helleiner 1994) Financial market integration in the EU substan-tially intensified after the introduction of the single currency and the completion of thesingle market in financial services envisaged by the Financial Services Action Plan in1999 EU rules to a large extent provide the framework for financial regulation in themember states However EU rules are also embedded into or coexist with internationalrules on certain activities The most notable examples are capital requirements for banksset by the Basel accords Unlike financial regulation which is mostly set at the EU levelfinancial supervision in the EU is mainly carried out at the national level by central banks(whenever they are responsible for banking supervision) or the banking supervisoryauthorities if separated from the central bank and the supervisors of other financial activ-ities (eg securities markets)

This fragmentation of powers and responsibilities severely constrains the publicauthoritiesrsquo ability to supervise financial markets and financial entities active in theirjurisdictions This is particularly problematic in the case of ailing cross-border financialinstitutions whereby the key issue is burden sharing that isrsquo the distribution of costsbetween the home and host countries and across the host jurisdictions in which cross-bor-der financial institutions operate (see Dyson and Quaglia 2010) Furthermore sometimesfinancial institutions are too big to be rescued by their home countries ultimately by thetreasury and taxpayers of the country in which they are headquartered This was the caseof the Icelandic banks operating cross-border in the EU This is a challenge not only forthe small countries but also for the large ones that are home countries of very big finan-cial entities For example the Deutsche Bank balance sheet amount to a significant shareof German GDP

Moreover the banking system of several central and eastern European countries is lar-gely foreign owned This raises three main concerns First there are banks that are ofsystemic importance in the new member states but not in the country in which they areheadquartered Second host supervisors can exert only limited control on foreign banksoperating in their jurisdictions particularly when they take the legal form of branchesThis point was stressed in the Turner report 2010 (Financial Services Authority 2009)which went as far as suggesting the compulsory transformation of branches into

26 L Quaglia

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

subsidiaries under specific circumstances In the case of subsidiaries which are separatelegal entities in the countries in which they operate key functions might well be centra-lised within the financial groups of which such subsidiaries are part de facto limiting thepower of the host country supervisors Thirdly there is the risk that as a consequence ofthe financial turmoil such banks might retreat (ie pull out funding) abruptly from thehost countries

The bank resolution regime proposed by the Commission in June 2012 after years ofpreparation and several rounds of public consultations does not fully address these short-comings Nor does the DGS directive Ultimately there is an inescapable link betweenfinancial supervision crisis management and resolution and fiscal power (that is theability to use taxpayer money to deal with ailing banks) Fiscal policy goes to the core ofnational sovereignty which explains the reluctance of member states to the creation ofpan-European institutions (be they DGS funds resolution funds or resolution authorities)in this field Moreover the costs and the benefits ensuing from the establishment of theseinstitutions are likely to be unequally distributed across the member states In the endcountries with sound banking systems will have to foot the bill of crisis resolution incountries with less stable banking systems All this raises the problem of the under provi-sion of the public good of financial stability meaning that everybody benefits from finan-cial stability but the costs of providing this public good tend to be specific

Second the global financial crisis brought into sharp relief the interconnection betweenmonetary policy macroeconomic imbalances and financial stability in particular theeffects that the former can have on the latter (see Aktas and Cortuk 2012) Several authorshave pointed out the effects of macroeconomic imbalances such as the permanent deficitsin the US balance of payments (Pauly 2009) and of relatively accommodating monetarypolicies in the US but also to some extent in the EU (Carmassi et al 2009) in fuelling theglobal financial crisis Moreover deficits in the balance of payments are generally accom-panied by fiscal imbalances in particular in Southern Europe where the sovereign debtcrisis followed the financial crisis In turn the sovereign debt crisis risked turning into abanking crisis showing the interconnection between the two types of crises (for a discus-sion of several interesting country studies see Hardie and Howarth forthcoming)

In some countries such as Ireland it was the financial crisis and ultimately the statersquosrescue of the banking system that substantially worsened the public finances (public defi-cit and debt) triggering the sovereign debt crisis In other countries such as Italy andGreece the sovereign debt crisis had domestic origins it was rooted in a loose fiscal pol-icy while the national banking sector was relatively sound and only marginally affectedby the financial (banking) crisis However once the Greek and Italian state faced defaulttheir banking systems were penalised and the sovereign debt crisis risked turning into abanking crisis The problems experienced by some Spanish banks gave new momentumto the idea of a banking union discussed above highlighting the vicious circle betweenbanks and sovereigns Especially in the case of the sovereign debt crisis some commen-tators have argued that the EU and in particular the European Commission is reactive notproactive For example the Nobel-laureate US economist Paul Krugman pointed outthe need for lsquoa Marshall plan for Europersquo (The Guardian 22 January 2012 see alsoKrugman 2012ab)

Conclusions

This article has examined the regulatory response of the EU to the financial crisis endingwith a concise discussion of the link between the financial crisis and the sovereign debt

Journal of Economic Policy Reform 27

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

crisis Set against the benchmarks outlined in the introduction it is possible to concludethat despite the new pieces of legislation adopted by the EU the framework for financialservices regulation and supervision in the EU is not substantially different from the pre-crisis one The main obstacles to more far-reaching reform were political not economic

The EU is generally a slow moving institution and tends to be reactive rather thanproactive It took the Commission more than three years and several rounds of consulta-tion to come forward with a formal legislative proposal for a banking resolution regimeNegotiations in the Council and EP have just started and are likely to be time consumingThe DGS directive officially proposed by the Commission in 2010 has not yet beenagreed The proposed Banking Union would represent quite a major reform Yet it is farfrom being agreed and political discussions are ongoing

The Commission is also trying to grapple with structural issues concerning the bank-ing sector in the EU In February 2012 it appointed a High-level Expert Group headedby Erkki Liikanen (former governor of the central bank of Finland) to examine structuralreforms that would directly affect the structure of individual banks and the market as awhole (High Level Expert Group 2012)6 Such reforms could for example includeprohibiting banks from carrying out some activities such as proprietary trading (asenvisaged in the Dodd-Frank act in the US) or requiring banks to ring-fence theirdeposit-taking activities from investment banking as proposed by the IndependentBanking Commission in the UK In this case as well the jury is still out

AcknowledgementsThe author wishes to acknowledge financial support from the European Research Council (204398FINGOVEU) and the British Academy (SG 120191) This paper was written while the author wasa visiting fellow at the Max Planck Institute the European University Institute and HanseWissenschaftskolleg

Notes1 httpeuropaeurapidpressReleasesActiondoreference=MEMO12416ampfor-

mat=HTMLampaged=0amplanguage=ENampguiLanguage=en2 Sweden has a significant private equity industry hence it was seen as having a vested interest

in the revision of the text of the directive3 All these legislative texts can be found at httpeceuropaeuinternal_marketfinancescommit-

teesindex_enhtm4 httpeuropaeurapidpress-release_MEMO-12-656_enhtmlocale=en5 httpeuropaeurapidpress-release_IP-12-953_enhtmlocale=en6 httpeuropaeurapidpressReleasesActiondoreference=MEMO12129ampfor-

mat=HTMLampaged=1amplanguage=ENampguiLanguage=en]

ReferencesAktas C and Cortuk O 2012 Turkeyrsquos experience with the global crisis restructuring policies

within a financial stability framework Journal of Economic Policy Reform 15 (3) 195ndash205Baker A 2012 The new political economy of the macroprudential ideational shift New Political

Economy iFirstBasel Committee on Banking Supervision 2010a Basel III A global regulatory framework for

more resilient banks and banking systems DecemberBasel Committee on Banking Supervision 2010b Basel III International framework for liquidity

risk measurement standards and monitoring DecemberBroby D 2012 The regulatory evolution of the post credit crisis fund management industry

Journal of Economic Policy Reform 15 (1) 5ndash11Brunnermeier M Crockett A Goodhart C Persaud AD Shin HS 2009 The fundamental

principles of financial regulation Geneva Reports on the World Economy 11

28 L Quaglia

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series of legislative proposals for the reform of the micro- and macro-prudential frame-work for financial supervision in the EU The Commission proposals were eventuallyagreed by the Council and European Parliament in the autumn of 2010 and were imple-mented in early 20113

The main institutional innovations were the establishment of the European SystemicRisk Board its chair to be elected by and from the members of the General Council ofthe European Central Bank (ECB) and in charge of monitoring macro-prudential risk thetransformation of the so-called level three Lamfalussy committees of national regulatorsinto independent authorities with legal personality an increased budget and enhancedpowers The newly created bodies namely the European Banking Authority the Euro-pean Insurance and Occupational Pension Authority and the European Securities MarketsAuthority were charged with the tasks of coordinating the application of supervisorystandards and promoting stronger cooperation between national supervisors Moreoverindividual ESAs were given specific roles for example ESMA is the EU supervisor ofcredit rating agencies while EBA and EIOPA carry out lsquostress testsrsquo of their respectivesectors Yet the new agencies have limited competences and their effective ability toregulate the financial sector remains to be seen

In the negotiations of these institutional reforms disagreements broke out in the Coun-cil and between the Council and the EP concerning the powers of the newly createdbodies as well as the role of the EP in the proposed architecture In the Council therewere (mainly British) concerns about giving the new authorities powers over national reg-ulators and the possibility of supervising individual financial cross-border institutions(Buckley and Howarth 2010) Besides the UK Ireland and Luxemburg were also reluctantto transfer powers away from national supervisors to bodies outside their borders More-over the UK government was reluctant to grant decision-making powers to EU-levelbodies while public funds to tackle banking crises came from national budgets To thiseffect Gordon Brown the British Prime Minister secured a guarantee that the new super-visory system would not include powers to force national governments to bail out banksThat said a number of Member States particularly those with large financial centresnamely the UK France and Germany favoured the limited reform approach and were hes-itant about transferring substantive power to the EU level (Buckley and Howarth 2010)This led to a significant reduction in the scope of the Commission proposals during thenegotiations in the Council By contrast the EP argued that the Commissionrsquos proposalsdid not go far enough and was adamant about safeguarding the powers of the ESAs andenhancing its own oversight role To some extent it was successful in doing so

The Banking Union

The belated banking crisis in Spain (see Royo forthcoming) which risked wreaking thepublic finance in this country exposed the vicious circle between the sovereign debt cri-sis and the financial (meaning banking) crisis In June 2012 the European Council andEuro Area summit agreed to deepen Economic and Monetary Union creating a lsquoBankingUnionrsquo (Euroarea statement 2012) This Union was to be based on four components asingle rulebook more integrated banking supervision a pan-EU deposit guaranteescheme a common EU-wide framework for the managed resolution of banks and finan-cial institutions The Member States decided to make the set-up of a single supervisorymechanism a precondition for the possible direct recapitalisation of banks by the Euro-pean Stability Mechanism (ESM) created to deal with the sovereign debt crisis

24 L Quaglia

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Bra

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ity G

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at 0

950

14

Apr

il 20

13

In September 2012 the Commission adopted a set of legislative proposals on theestablishment of a single supervisory mechanism led by the ECB The proposals con-cerned a regulation giving strong powers for the supervision of all banks in the euro areato the ECB and national supervisory authorities a regulation with limited specificchanges to the regulation setting up the European Banking Authority (EBA) to ensure abalance in its decision making structures between the euro area and non-euro area Mem-ber States a communication on a roadmap for completing the banking union over thecoming years covering the single rulebook common deposit protection and a single bankresolution mechanism4

In the new single mechanism ultimate responsibility for specific supervisory tasksrelated to the financial stability of all Euro area banks will lie with the ECB Nationalsupervisors will continue to play an important role in day-to-day supervision and in pre-paring and implementing ECB decisions The ECB will become responsible for taskssuch as authorising credit institutions compliance with capital leverage and liquidityrequirements and conducting supervision of financial conglomerates (Commission of theEuropean Communities 2012a) The ECB will be able to carry out early interventionmeasures when a bank breaches or risks breaching regulatory capital requirements byrequiring banks to take remedial action The Commission also proposed the developmentof the Single Supervisory Handbook by the European Banking Authority (EBA)

The ECB will cooperate with the EBA within the framework of the European Systemof financial supervision The role of the EBA will be similar to today it will continuedeveloping the single rulebook applicable to all 27 Member States and make sure thatsupervisory practices are consistent across the whole Union5 After agreement on thepending proposals as a next step the Commission envisages making a proposal for a sin-gle European resolution mechanism The political discussions on this reform are stillongoing

3 An overall assessment of the reforms in the EU and the main open issues

Three main features of the regulatory measures adopted or officially proposed by the EUin the wake of the crisis stand out First the reforms enacted either regulated activities orfinancial institutions that were previously unregulated in the EU and its member states(CRAs) or at the EU level (AIFMs) or at the national EU and international level(OTCDs) In other instances they imposed heavier more prescriptive and more burden-some requirements on financial entities that were already regulated prior to the crisis asin the case of higher capital requirements for banks and new liquidity management rules(Basel III) or they set in place more substantial protection for depositors (the DGSD)That said some key controversial issues discussed below were not fully addressed

Second although with some notable exceptions the new or amended rules were gen-erally resisted by the UK Ireland Luxemburg and a variable mix of Nordic countriesThe market players primarily affected by the new or revised rules such as CRAs andAIFMs initially resisted the proposed rules Subsequently they engaged in intense lobby-ing with a view to having the proposed rules amended on the grounds that they would beover-prescriptive and costly to implement creating potential regulatory arbitrage vis-agrave-viscountries outside the EU (Quaglia 2012) A somewhat special case was the new capitaland liquidity rules whereby the UK favoured new strict rules on capital requirementsand liquidity provisions whereas France Germany and Italy called for lsquosofterrsquo rules anda longer transition period

Journal of Economic Policy Reform 25

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

Third the pace of reform was somewhat piecemeal in the EU This has partly to dowith the interlocking mechanisms of policy making in the EU where there are severalveto players The main agenda-setter of the reform efforts was the Commission which isthe only body that can officially propose legislation in the EU Of course the Commis-sion did so after consulting the member states informally and after holding open publicconsultations In certain cases the Commission was spurred to act by the initiatives ofthe EP as in the case of CRAs and by the continental member states as in the case ofAIFM The Council and the EP were the main decision-makers because they had thepower to adopt or amend the legislation proposed by the Commission Often the memberstates had different priorities and they were worried about potential regulatory arbitragewith jurisdictions outside the EU Lobbying from the financial industry which was keento limit the extent of regulatory change at the national EU and international levels insome cases watered down the proposed reforms but so did the political disagreementbetween the member states

Several problematic issues were highlighted by the crisis and they were only partiallyaddressed by the reforms implemented by the EU afterward The first is the disjuncturebetween globalised financial markets financial market integration in the EU EU financialregulation and national systems of supervision A vast body of international politicaleconomy literature has discussed the internationalisation or globalisation of finance fromthe 1990s onwards (see Helleiner 1994) Financial market integration in the EU substan-tially intensified after the introduction of the single currency and the completion of thesingle market in financial services envisaged by the Financial Services Action Plan in1999 EU rules to a large extent provide the framework for financial regulation in themember states However EU rules are also embedded into or coexist with internationalrules on certain activities The most notable examples are capital requirements for banksset by the Basel accords Unlike financial regulation which is mostly set at the EU levelfinancial supervision in the EU is mainly carried out at the national level by central banks(whenever they are responsible for banking supervision) or the banking supervisoryauthorities if separated from the central bank and the supervisors of other financial activ-ities (eg securities markets)

This fragmentation of powers and responsibilities severely constrains the publicauthoritiesrsquo ability to supervise financial markets and financial entities active in theirjurisdictions This is particularly problematic in the case of ailing cross-border financialinstitutions whereby the key issue is burden sharing that isrsquo the distribution of costsbetween the home and host countries and across the host jurisdictions in which cross-bor-der financial institutions operate (see Dyson and Quaglia 2010) Furthermore sometimesfinancial institutions are too big to be rescued by their home countries ultimately by thetreasury and taxpayers of the country in which they are headquartered This was the caseof the Icelandic banks operating cross-border in the EU This is a challenge not only forthe small countries but also for the large ones that are home countries of very big finan-cial entities For example the Deutsche Bank balance sheet amount to a significant shareof German GDP

Moreover the banking system of several central and eastern European countries is lar-gely foreign owned This raises three main concerns First there are banks that are ofsystemic importance in the new member states but not in the country in which they areheadquartered Second host supervisors can exert only limited control on foreign banksoperating in their jurisdictions particularly when they take the legal form of branchesThis point was stressed in the Turner report 2010 (Financial Services Authority 2009)which went as far as suggesting the compulsory transformation of branches into

26 L Quaglia

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

subsidiaries under specific circumstances In the case of subsidiaries which are separatelegal entities in the countries in which they operate key functions might well be centra-lised within the financial groups of which such subsidiaries are part de facto limiting thepower of the host country supervisors Thirdly there is the risk that as a consequence ofthe financial turmoil such banks might retreat (ie pull out funding) abruptly from thehost countries

The bank resolution regime proposed by the Commission in June 2012 after years ofpreparation and several rounds of public consultations does not fully address these short-comings Nor does the DGS directive Ultimately there is an inescapable link betweenfinancial supervision crisis management and resolution and fiscal power (that is theability to use taxpayer money to deal with ailing banks) Fiscal policy goes to the core ofnational sovereignty which explains the reluctance of member states to the creation ofpan-European institutions (be they DGS funds resolution funds or resolution authorities)in this field Moreover the costs and the benefits ensuing from the establishment of theseinstitutions are likely to be unequally distributed across the member states In the endcountries with sound banking systems will have to foot the bill of crisis resolution incountries with less stable banking systems All this raises the problem of the under provi-sion of the public good of financial stability meaning that everybody benefits from finan-cial stability but the costs of providing this public good tend to be specific

Second the global financial crisis brought into sharp relief the interconnection betweenmonetary policy macroeconomic imbalances and financial stability in particular theeffects that the former can have on the latter (see Aktas and Cortuk 2012) Several authorshave pointed out the effects of macroeconomic imbalances such as the permanent deficitsin the US balance of payments (Pauly 2009) and of relatively accommodating monetarypolicies in the US but also to some extent in the EU (Carmassi et al 2009) in fuelling theglobal financial crisis Moreover deficits in the balance of payments are generally accom-panied by fiscal imbalances in particular in Southern Europe where the sovereign debtcrisis followed the financial crisis In turn the sovereign debt crisis risked turning into abanking crisis showing the interconnection between the two types of crises (for a discus-sion of several interesting country studies see Hardie and Howarth forthcoming)

In some countries such as Ireland it was the financial crisis and ultimately the statersquosrescue of the banking system that substantially worsened the public finances (public defi-cit and debt) triggering the sovereign debt crisis In other countries such as Italy andGreece the sovereign debt crisis had domestic origins it was rooted in a loose fiscal pol-icy while the national banking sector was relatively sound and only marginally affectedby the financial (banking) crisis However once the Greek and Italian state faced defaulttheir banking systems were penalised and the sovereign debt crisis risked turning into abanking crisis The problems experienced by some Spanish banks gave new momentumto the idea of a banking union discussed above highlighting the vicious circle betweenbanks and sovereigns Especially in the case of the sovereign debt crisis some commen-tators have argued that the EU and in particular the European Commission is reactive notproactive For example the Nobel-laureate US economist Paul Krugman pointed outthe need for lsquoa Marshall plan for Europersquo (The Guardian 22 January 2012 see alsoKrugman 2012ab)

Conclusions

This article has examined the regulatory response of the EU to the financial crisis endingwith a concise discussion of the link between the financial crisis and the sovereign debt

Journal of Economic Policy Reform 27

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

crisis Set against the benchmarks outlined in the introduction it is possible to concludethat despite the new pieces of legislation adopted by the EU the framework for financialservices regulation and supervision in the EU is not substantially different from the pre-crisis one The main obstacles to more far-reaching reform were political not economic

The EU is generally a slow moving institution and tends to be reactive rather thanproactive It took the Commission more than three years and several rounds of consulta-tion to come forward with a formal legislative proposal for a banking resolution regimeNegotiations in the Council and EP have just started and are likely to be time consumingThe DGS directive officially proposed by the Commission in 2010 has not yet beenagreed The proposed Banking Union would represent quite a major reform Yet it is farfrom being agreed and political discussions are ongoing

The Commission is also trying to grapple with structural issues concerning the bank-ing sector in the EU In February 2012 it appointed a High-level Expert Group headedby Erkki Liikanen (former governor of the central bank of Finland) to examine structuralreforms that would directly affect the structure of individual banks and the market as awhole (High Level Expert Group 2012)6 Such reforms could for example includeprohibiting banks from carrying out some activities such as proprietary trading (asenvisaged in the Dodd-Frank act in the US) or requiring banks to ring-fence theirdeposit-taking activities from investment banking as proposed by the IndependentBanking Commission in the UK In this case as well the jury is still out

AcknowledgementsThe author wishes to acknowledge financial support from the European Research Council (204398FINGOVEU) and the British Academy (SG 120191) This paper was written while the author wasa visiting fellow at the Max Planck Institute the European University Institute and HanseWissenschaftskolleg

Notes1 httpeuropaeurapidpressReleasesActiondoreference=MEMO12416ampfor-

mat=HTMLampaged=0amplanguage=ENampguiLanguage=en2 Sweden has a significant private equity industry hence it was seen as having a vested interest

in the revision of the text of the directive3 All these legislative texts can be found at httpeceuropaeuinternal_marketfinancescommit-

teesindex_enhtm4 httpeuropaeurapidpress-release_MEMO-12-656_enhtmlocale=en5 httpeuropaeurapidpress-release_IP-12-953_enhtmlocale=en6 httpeuropaeurapidpressReleasesActiondoreference=MEMO12129ampfor-

mat=HTMLampaged=1amplanguage=ENampguiLanguage=en]

ReferencesAktas C and Cortuk O 2012 Turkeyrsquos experience with the global crisis restructuring policies

within a financial stability framework Journal of Economic Policy Reform 15 (3) 195ndash205Baker A 2012 The new political economy of the macroprudential ideational shift New Political

Economy iFirstBasel Committee on Banking Supervision 2010a Basel III A global regulatory framework for

more resilient banks and banking systems DecemberBasel Committee on Banking Supervision 2010b Basel III International framework for liquidity

risk measurement standards and monitoring DecemberBroby D 2012 The regulatory evolution of the post credit crisis fund management industry

Journal of Economic Policy Reform 15 (1) 5ndash11Brunnermeier M Crockett A Goodhart C Persaud AD Shin HS 2009 The fundamental

principles of financial regulation Geneva Reports on the World Economy 11

28 L Quaglia

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

In September 2012 the Commission adopted a set of legislative proposals on theestablishment of a single supervisory mechanism led by the ECB The proposals con-cerned a regulation giving strong powers for the supervision of all banks in the euro areato the ECB and national supervisory authorities a regulation with limited specificchanges to the regulation setting up the European Banking Authority (EBA) to ensure abalance in its decision making structures between the euro area and non-euro area Mem-ber States a communication on a roadmap for completing the banking union over thecoming years covering the single rulebook common deposit protection and a single bankresolution mechanism4

In the new single mechanism ultimate responsibility for specific supervisory tasksrelated to the financial stability of all Euro area banks will lie with the ECB Nationalsupervisors will continue to play an important role in day-to-day supervision and in pre-paring and implementing ECB decisions The ECB will become responsible for taskssuch as authorising credit institutions compliance with capital leverage and liquidityrequirements and conducting supervision of financial conglomerates (Commission of theEuropean Communities 2012a) The ECB will be able to carry out early interventionmeasures when a bank breaches or risks breaching regulatory capital requirements byrequiring banks to take remedial action The Commission also proposed the developmentof the Single Supervisory Handbook by the European Banking Authority (EBA)

The ECB will cooperate with the EBA within the framework of the European Systemof financial supervision The role of the EBA will be similar to today it will continuedeveloping the single rulebook applicable to all 27 Member States and make sure thatsupervisory practices are consistent across the whole Union5 After agreement on thepending proposals as a next step the Commission envisages making a proposal for a sin-gle European resolution mechanism The political discussions on this reform are stillongoing

3 An overall assessment of the reforms in the EU and the main open issues

Three main features of the regulatory measures adopted or officially proposed by the EUin the wake of the crisis stand out First the reforms enacted either regulated activities orfinancial institutions that were previously unregulated in the EU and its member states(CRAs) or at the EU level (AIFMs) or at the national EU and international level(OTCDs) In other instances they imposed heavier more prescriptive and more burden-some requirements on financial entities that were already regulated prior to the crisis asin the case of higher capital requirements for banks and new liquidity management rules(Basel III) or they set in place more substantial protection for depositors (the DGSD)That said some key controversial issues discussed below were not fully addressed

Second although with some notable exceptions the new or amended rules were gen-erally resisted by the UK Ireland Luxemburg and a variable mix of Nordic countriesThe market players primarily affected by the new or revised rules such as CRAs andAIFMs initially resisted the proposed rules Subsequently they engaged in intense lobby-ing with a view to having the proposed rules amended on the grounds that they would beover-prescriptive and costly to implement creating potential regulatory arbitrage vis-agrave-viscountries outside the EU (Quaglia 2012) A somewhat special case was the new capitaland liquidity rules whereby the UK favoured new strict rules on capital requirementsand liquidity provisions whereas France Germany and Italy called for lsquosofterrsquo rules anda longer transition period

Journal of Economic Policy Reform 25

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

Third the pace of reform was somewhat piecemeal in the EU This has partly to dowith the interlocking mechanisms of policy making in the EU where there are severalveto players The main agenda-setter of the reform efforts was the Commission which isthe only body that can officially propose legislation in the EU Of course the Commis-sion did so after consulting the member states informally and after holding open publicconsultations In certain cases the Commission was spurred to act by the initiatives ofthe EP as in the case of CRAs and by the continental member states as in the case ofAIFM The Council and the EP were the main decision-makers because they had thepower to adopt or amend the legislation proposed by the Commission Often the memberstates had different priorities and they were worried about potential regulatory arbitragewith jurisdictions outside the EU Lobbying from the financial industry which was keento limit the extent of regulatory change at the national EU and international levels insome cases watered down the proposed reforms but so did the political disagreementbetween the member states

Several problematic issues were highlighted by the crisis and they were only partiallyaddressed by the reforms implemented by the EU afterward The first is the disjuncturebetween globalised financial markets financial market integration in the EU EU financialregulation and national systems of supervision A vast body of international politicaleconomy literature has discussed the internationalisation or globalisation of finance fromthe 1990s onwards (see Helleiner 1994) Financial market integration in the EU substan-tially intensified after the introduction of the single currency and the completion of thesingle market in financial services envisaged by the Financial Services Action Plan in1999 EU rules to a large extent provide the framework for financial regulation in themember states However EU rules are also embedded into or coexist with internationalrules on certain activities The most notable examples are capital requirements for banksset by the Basel accords Unlike financial regulation which is mostly set at the EU levelfinancial supervision in the EU is mainly carried out at the national level by central banks(whenever they are responsible for banking supervision) or the banking supervisoryauthorities if separated from the central bank and the supervisors of other financial activ-ities (eg securities markets)

This fragmentation of powers and responsibilities severely constrains the publicauthoritiesrsquo ability to supervise financial markets and financial entities active in theirjurisdictions This is particularly problematic in the case of ailing cross-border financialinstitutions whereby the key issue is burden sharing that isrsquo the distribution of costsbetween the home and host countries and across the host jurisdictions in which cross-bor-der financial institutions operate (see Dyson and Quaglia 2010) Furthermore sometimesfinancial institutions are too big to be rescued by their home countries ultimately by thetreasury and taxpayers of the country in which they are headquartered This was the caseof the Icelandic banks operating cross-border in the EU This is a challenge not only forthe small countries but also for the large ones that are home countries of very big finan-cial entities For example the Deutsche Bank balance sheet amount to a significant shareof German GDP

Moreover the banking system of several central and eastern European countries is lar-gely foreign owned This raises three main concerns First there are banks that are ofsystemic importance in the new member states but not in the country in which they areheadquartered Second host supervisors can exert only limited control on foreign banksoperating in their jurisdictions particularly when they take the legal form of branchesThis point was stressed in the Turner report 2010 (Financial Services Authority 2009)which went as far as suggesting the compulsory transformation of branches into

26 L Quaglia

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

subsidiaries under specific circumstances In the case of subsidiaries which are separatelegal entities in the countries in which they operate key functions might well be centra-lised within the financial groups of which such subsidiaries are part de facto limiting thepower of the host country supervisors Thirdly there is the risk that as a consequence ofthe financial turmoil such banks might retreat (ie pull out funding) abruptly from thehost countries

The bank resolution regime proposed by the Commission in June 2012 after years ofpreparation and several rounds of public consultations does not fully address these short-comings Nor does the DGS directive Ultimately there is an inescapable link betweenfinancial supervision crisis management and resolution and fiscal power (that is theability to use taxpayer money to deal with ailing banks) Fiscal policy goes to the core ofnational sovereignty which explains the reluctance of member states to the creation ofpan-European institutions (be they DGS funds resolution funds or resolution authorities)in this field Moreover the costs and the benefits ensuing from the establishment of theseinstitutions are likely to be unequally distributed across the member states In the endcountries with sound banking systems will have to foot the bill of crisis resolution incountries with less stable banking systems All this raises the problem of the under provi-sion of the public good of financial stability meaning that everybody benefits from finan-cial stability but the costs of providing this public good tend to be specific

Second the global financial crisis brought into sharp relief the interconnection betweenmonetary policy macroeconomic imbalances and financial stability in particular theeffects that the former can have on the latter (see Aktas and Cortuk 2012) Several authorshave pointed out the effects of macroeconomic imbalances such as the permanent deficitsin the US balance of payments (Pauly 2009) and of relatively accommodating monetarypolicies in the US but also to some extent in the EU (Carmassi et al 2009) in fuelling theglobal financial crisis Moreover deficits in the balance of payments are generally accom-panied by fiscal imbalances in particular in Southern Europe where the sovereign debtcrisis followed the financial crisis In turn the sovereign debt crisis risked turning into abanking crisis showing the interconnection between the two types of crises (for a discus-sion of several interesting country studies see Hardie and Howarth forthcoming)

In some countries such as Ireland it was the financial crisis and ultimately the statersquosrescue of the banking system that substantially worsened the public finances (public defi-cit and debt) triggering the sovereign debt crisis In other countries such as Italy andGreece the sovereign debt crisis had domestic origins it was rooted in a loose fiscal pol-icy while the national banking sector was relatively sound and only marginally affectedby the financial (banking) crisis However once the Greek and Italian state faced defaulttheir banking systems were penalised and the sovereign debt crisis risked turning into abanking crisis The problems experienced by some Spanish banks gave new momentumto the idea of a banking union discussed above highlighting the vicious circle betweenbanks and sovereigns Especially in the case of the sovereign debt crisis some commen-tators have argued that the EU and in particular the European Commission is reactive notproactive For example the Nobel-laureate US economist Paul Krugman pointed outthe need for lsquoa Marshall plan for Europersquo (The Guardian 22 January 2012 see alsoKrugman 2012ab)

Conclusions

This article has examined the regulatory response of the EU to the financial crisis endingwith a concise discussion of the link between the financial crisis and the sovereign debt

Journal of Economic Policy Reform 27

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

crisis Set against the benchmarks outlined in the introduction it is possible to concludethat despite the new pieces of legislation adopted by the EU the framework for financialservices regulation and supervision in the EU is not substantially different from the pre-crisis one The main obstacles to more far-reaching reform were political not economic

The EU is generally a slow moving institution and tends to be reactive rather thanproactive It took the Commission more than three years and several rounds of consulta-tion to come forward with a formal legislative proposal for a banking resolution regimeNegotiations in the Council and EP have just started and are likely to be time consumingThe DGS directive officially proposed by the Commission in 2010 has not yet beenagreed The proposed Banking Union would represent quite a major reform Yet it is farfrom being agreed and political discussions are ongoing

The Commission is also trying to grapple with structural issues concerning the bank-ing sector in the EU In February 2012 it appointed a High-level Expert Group headedby Erkki Liikanen (former governor of the central bank of Finland) to examine structuralreforms that would directly affect the structure of individual banks and the market as awhole (High Level Expert Group 2012)6 Such reforms could for example includeprohibiting banks from carrying out some activities such as proprietary trading (asenvisaged in the Dodd-Frank act in the US) or requiring banks to ring-fence theirdeposit-taking activities from investment banking as proposed by the IndependentBanking Commission in the UK In this case as well the jury is still out

AcknowledgementsThe author wishes to acknowledge financial support from the European Research Council (204398FINGOVEU) and the British Academy (SG 120191) This paper was written while the author wasa visiting fellow at the Max Planck Institute the European University Institute and HanseWissenschaftskolleg

Notes1 httpeuropaeurapidpressReleasesActiondoreference=MEMO12416ampfor-

mat=HTMLampaged=0amplanguage=ENampguiLanguage=en2 Sweden has a significant private equity industry hence it was seen as having a vested interest

in the revision of the text of the directive3 All these legislative texts can be found at httpeceuropaeuinternal_marketfinancescommit-

teesindex_enhtm4 httpeuropaeurapidpress-release_MEMO-12-656_enhtmlocale=en5 httpeuropaeurapidpress-release_IP-12-953_enhtmlocale=en6 httpeuropaeurapidpressReleasesActiondoreference=MEMO12129ampfor-

mat=HTMLampaged=1amplanguage=ENampguiLanguage=en]

ReferencesAktas C and Cortuk O 2012 Turkeyrsquos experience with the global crisis restructuring policies

within a financial stability framework Journal of Economic Policy Reform 15 (3) 195ndash205Baker A 2012 The new political economy of the macroprudential ideational shift New Political

Economy iFirstBasel Committee on Banking Supervision 2010a Basel III A global regulatory framework for

more resilient banks and banking systems DecemberBasel Committee on Banking Supervision 2010b Basel III International framework for liquidity

risk measurement standards and monitoring DecemberBroby D 2012 The regulatory evolution of the post credit crisis fund management industry

Journal of Economic Policy Reform 15 (1) 5ndash11Brunnermeier M Crockett A Goodhart C Persaud AD Shin HS 2009 The fundamental

principles of financial regulation Geneva Reports on the World Economy 11

28 L Quaglia

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

Third the pace of reform was somewhat piecemeal in the EU This has partly to dowith the interlocking mechanisms of policy making in the EU where there are severalveto players The main agenda-setter of the reform efforts was the Commission which isthe only body that can officially propose legislation in the EU Of course the Commis-sion did so after consulting the member states informally and after holding open publicconsultations In certain cases the Commission was spurred to act by the initiatives ofthe EP as in the case of CRAs and by the continental member states as in the case ofAIFM The Council and the EP were the main decision-makers because they had thepower to adopt or amend the legislation proposed by the Commission Often the memberstates had different priorities and they were worried about potential regulatory arbitragewith jurisdictions outside the EU Lobbying from the financial industry which was keento limit the extent of regulatory change at the national EU and international levels insome cases watered down the proposed reforms but so did the political disagreementbetween the member states

Several problematic issues were highlighted by the crisis and they were only partiallyaddressed by the reforms implemented by the EU afterward The first is the disjuncturebetween globalised financial markets financial market integration in the EU EU financialregulation and national systems of supervision A vast body of international politicaleconomy literature has discussed the internationalisation or globalisation of finance fromthe 1990s onwards (see Helleiner 1994) Financial market integration in the EU substan-tially intensified after the introduction of the single currency and the completion of thesingle market in financial services envisaged by the Financial Services Action Plan in1999 EU rules to a large extent provide the framework for financial regulation in themember states However EU rules are also embedded into or coexist with internationalrules on certain activities The most notable examples are capital requirements for banksset by the Basel accords Unlike financial regulation which is mostly set at the EU levelfinancial supervision in the EU is mainly carried out at the national level by central banks(whenever they are responsible for banking supervision) or the banking supervisoryauthorities if separated from the central bank and the supervisors of other financial activ-ities (eg securities markets)

This fragmentation of powers and responsibilities severely constrains the publicauthoritiesrsquo ability to supervise financial markets and financial entities active in theirjurisdictions This is particularly problematic in the case of ailing cross-border financialinstitutions whereby the key issue is burden sharing that isrsquo the distribution of costsbetween the home and host countries and across the host jurisdictions in which cross-bor-der financial institutions operate (see Dyson and Quaglia 2010) Furthermore sometimesfinancial institutions are too big to be rescued by their home countries ultimately by thetreasury and taxpayers of the country in which they are headquartered This was the caseof the Icelandic banks operating cross-border in the EU This is a challenge not only forthe small countries but also for the large ones that are home countries of very big finan-cial entities For example the Deutsche Bank balance sheet amount to a significant shareof German GDP

Moreover the banking system of several central and eastern European countries is lar-gely foreign owned This raises three main concerns First there are banks that are ofsystemic importance in the new member states but not in the country in which they areheadquartered Second host supervisors can exert only limited control on foreign banksoperating in their jurisdictions particularly when they take the legal form of branchesThis point was stressed in the Turner report 2010 (Financial Services Authority 2009)which went as far as suggesting the compulsory transformation of branches into

26 L Quaglia

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

subsidiaries under specific circumstances In the case of subsidiaries which are separatelegal entities in the countries in which they operate key functions might well be centra-lised within the financial groups of which such subsidiaries are part de facto limiting thepower of the host country supervisors Thirdly there is the risk that as a consequence ofthe financial turmoil such banks might retreat (ie pull out funding) abruptly from thehost countries

The bank resolution regime proposed by the Commission in June 2012 after years ofpreparation and several rounds of public consultations does not fully address these short-comings Nor does the DGS directive Ultimately there is an inescapable link betweenfinancial supervision crisis management and resolution and fiscal power (that is theability to use taxpayer money to deal with ailing banks) Fiscal policy goes to the core ofnational sovereignty which explains the reluctance of member states to the creation ofpan-European institutions (be they DGS funds resolution funds or resolution authorities)in this field Moreover the costs and the benefits ensuing from the establishment of theseinstitutions are likely to be unequally distributed across the member states In the endcountries with sound banking systems will have to foot the bill of crisis resolution incountries with less stable banking systems All this raises the problem of the under provi-sion of the public good of financial stability meaning that everybody benefits from finan-cial stability but the costs of providing this public good tend to be specific

Second the global financial crisis brought into sharp relief the interconnection betweenmonetary policy macroeconomic imbalances and financial stability in particular theeffects that the former can have on the latter (see Aktas and Cortuk 2012) Several authorshave pointed out the effects of macroeconomic imbalances such as the permanent deficitsin the US balance of payments (Pauly 2009) and of relatively accommodating monetarypolicies in the US but also to some extent in the EU (Carmassi et al 2009) in fuelling theglobal financial crisis Moreover deficits in the balance of payments are generally accom-panied by fiscal imbalances in particular in Southern Europe where the sovereign debtcrisis followed the financial crisis In turn the sovereign debt crisis risked turning into abanking crisis showing the interconnection between the two types of crises (for a discus-sion of several interesting country studies see Hardie and Howarth forthcoming)

In some countries such as Ireland it was the financial crisis and ultimately the statersquosrescue of the banking system that substantially worsened the public finances (public defi-cit and debt) triggering the sovereign debt crisis In other countries such as Italy andGreece the sovereign debt crisis had domestic origins it was rooted in a loose fiscal pol-icy while the national banking sector was relatively sound and only marginally affectedby the financial (banking) crisis However once the Greek and Italian state faced defaulttheir banking systems were penalised and the sovereign debt crisis risked turning into abanking crisis The problems experienced by some Spanish banks gave new momentumto the idea of a banking union discussed above highlighting the vicious circle betweenbanks and sovereigns Especially in the case of the sovereign debt crisis some commen-tators have argued that the EU and in particular the European Commission is reactive notproactive For example the Nobel-laureate US economist Paul Krugman pointed outthe need for lsquoa Marshall plan for Europersquo (The Guardian 22 January 2012 see alsoKrugman 2012ab)

Conclusions

This article has examined the regulatory response of the EU to the financial crisis endingwith a concise discussion of the link between the financial crisis and the sovereign debt

Journal of Economic Policy Reform 27

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

crisis Set against the benchmarks outlined in the introduction it is possible to concludethat despite the new pieces of legislation adopted by the EU the framework for financialservices regulation and supervision in the EU is not substantially different from the pre-crisis one The main obstacles to more far-reaching reform were political not economic

The EU is generally a slow moving institution and tends to be reactive rather thanproactive It took the Commission more than three years and several rounds of consulta-tion to come forward with a formal legislative proposal for a banking resolution regimeNegotiations in the Council and EP have just started and are likely to be time consumingThe DGS directive officially proposed by the Commission in 2010 has not yet beenagreed The proposed Banking Union would represent quite a major reform Yet it is farfrom being agreed and political discussions are ongoing

The Commission is also trying to grapple with structural issues concerning the bank-ing sector in the EU In February 2012 it appointed a High-level Expert Group headedby Erkki Liikanen (former governor of the central bank of Finland) to examine structuralreforms that would directly affect the structure of individual banks and the market as awhole (High Level Expert Group 2012)6 Such reforms could for example includeprohibiting banks from carrying out some activities such as proprietary trading (asenvisaged in the Dodd-Frank act in the US) or requiring banks to ring-fence theirdeposit-taking activities from investment banking as proposed by the IndependentBanking Commission in the UK In this case as well the jury is still out

AcknowledgementsThe author wishes to acknowledge financial support from the European Research Council (204398FINGOVEU) and the British Academy (SG 120191) This paper was written while the author wasa visiting fellow at the Max Planck Institute the European University Institute and HanseWissenschaftskolleg

Notes1 httpeuropaeurapidpressReleasesActiondoreference=MEMO12416ampfor-

mat=HTMLampaged=0amplanguage=ENampguiLanguage=en2 Sweden has a significant private equity industry hence it was seen as having a vested interest

in the revision of the text of the directive3 All these legislative texts can be found at httpeceuropaeuinternal_marketfinancescommit-

teesindex_enhtm4 httpeuropaeurapidpress-release_MEMO-12-656_enhtmlocale=en5 httpeuropaeurapidpress-release_IP-12-953_enhtmlocale=en6 httpeuropaeurapidpressReleasesActiondoreference=MEMO12129ampfor-

mat=HTMLampaged=1amplanguage=ENampguiLanguage=en]

ReferencesAktas C and Cortuk O 2012 Turkeyrsquos experience with the global crisis restructuring policies

within a financial stability framework Journal of Economic Policy Reform 15 (3) 195ndash205Baker A 2012 The new political economy of the macroprudential ideational shift New Political

Economy iFirstBasel Committee on Banking Supervision 2010a Basel III A global regulatory framework for

more resilient banks and banking systems DecemberBasel Committee on Banking Supervision 2010b Basel III International framework for liquidity

risk measurement standards and monitoring DecemberBroby D 2012 The regulatory evolution of the post credit crisis fund management industry

Journal of Economic Policy Reform 15 (1) 5ndash11Brunnermeier M Crockett A Goodhart C Persaud AD Shin HS 2009 The fundamental

principles of financial regulation Geneva Reports on the World Economy 11

28 L Quaglia

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

subsidiaries under specific circumstances In the case of subsidiaries which are separatelegal entities in the countries in which they operate key functions might well be centra-lised within the financial groups of which such subsidiaries are part de facto limiting thepower of the host country supervisors Thirdly there is the risk that as a consequence ofthe financial turmoil such banks might retreat (ie pull out funding) abruptly from thehost countries

The bank resolution regime proposed by the Commission in June 2012 after years ofpreparation and several rounds of public consultations does not fully address these short-comings Nor does the DGS directive Ultimately there is an inescapable link betweenfinancial supervision crisis management and resolution and fiscal power (that is theability to use taxpayer money to deal with ailing banks) Fiscal policy goes to the core ofnational sovereignty which explains the reluctance of member states to the creation ofpan-European institutions (be they DGS funds resolution funds or resolution authorities)in this field Moreover the costs and the benefits ensuing from the establishment of theseinstitutions are likely to be unequally distributed across the member states In the endcountries with sound banking systems will have to foot the bill of crisis resolution incountries with less stable banking systems All this raises the problem of the under provi-sion of the public good of financial stability meaning that everybody benefits from finan-cial stability but the costs of providing this public good tend to be specific

Second the global financial crisis brought into sharp relief the interconnection betweenmonetary policy macroeconomic imbalances and financial stability in particular theeffects that the former can have on the latter (see Aktas and Cortuk 2012) Several authorshave pointed out the effects of macroeconomic imbalances such as the permanent deficitsin the US balance of payments (Pauly 2009) and of relatively accommodating monetarypolicies in the US but also to some extent in the EU (Carmassi et al 2009) in fuelling theglobal financial crisis Moreover deficits in the balance of payments are generally accom-panied by fiscal imbalances in particular in Southern Europe where the sovereign debtcrisis followed the financial crisis In turn the sovereign debt crisis risked turning into abanking crisis showing the interconnection between the two types of crises (for a discus-sion of several interesting country studies see Hardie and Howarth forthcoming)

In some countries such as Ireland it was the financial crisis and ultimately the statersquosrescue of the banking system that substantially worsened the public finances (public defi-cit and debt) triggering the sovereign debt crisis In other countries such as Italy andGreece the sovereign debt crisis had domestic origins it was rooted in a loose fiscal pol-icy while the national banking sector was relatively sound and only marginally affectedby the financial (banking) crisis However once the Greek and Italian state faced defaulttheir banking systems were penalised and the sovereign debt crisis risked turning into abanking crisis The problems experienced by some Spanish banks gave new momentumto the idea of a banking union discussed above highlighting the vicious circle betweenbanks and sovereigns Especially in the case of the sovereign debt crisis some commen-tators have argued that the EU and in particular the European Commission is reactive notproactive For example the Nobel-laureate US economist Paul Krugman pointed outthe need for lsquoa Marshall plan for Europersquo (The Guardian 22 January 2012 see alsoKrugman 2012ab)

Conclusions

This article has examined the regulatory response of the EU to the financial crisis endingwith a concise discussion of the link between the financial crisis and the sovereign debt

Journal of Economic Policy Reform 27

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

crisis Set against the benchmarks outlined in the introduction it is possible to concludethat despite the new pieces of legislation adopted by the EU the framework for financialservices regulation and supervision in the EU is not substantially different from the pre-crisis one The main obstacles to more far-reaching reform were political not economic

The EU is generally a slow moving institution and tends to be reactive rather thanproactive It took the Commission more than three years and several rounds of consulta-tion to come forward with a formal legislative proposal for a banking resolution regimeNegotiations in the Council and EP have just started and are likely to be time consumingThe DGS directive officially proposed by the Commission in 2010 has not yet beenagreed The proposed Banking Union would represent quite a major reform Yet it is farfrom being agreed and political discussions are ongoing

The Commission is also trying to grapple with structural issues concerning the bank-ing sector in the EU In February 2012 it appointed a High-level Expert Group headedby Erkki Liikanen (former governor of the central bank of Finland) to examine structuralreforms that would directly affect the structure of individual banks and the market as awhole (High Level Expert Group 2012)6 Such reforms could for example includeprohibiting banks from carrying out some activities such as proprietary trading (asenvisaged in the Dodd-Frank act in the US) or requiring banks to ring-fence theirdeposit-taking activities from investment banking as proposed by the IndependentBanking Commission in the UK In this case as well the jury is still out

AcknowledgementsThe author wishes to acknowledge financial support from the European Research Council (204398FINGOVEU) and the British Academy (SG 120191) This paper was written while the author wasa visiting fellow at the Max Planck Institute the European University Institute and HanseWissenschaftskolleg

Notes1 httpeuropaeurapidpressReleasesActiondoreference=MEMO12416ampfor-

mat=HTMLampaged=0amplanguage=ENampguiLanguage=en2 Sweden has a significant private equity industry hence it was seen as having a vested interest

in the revision of the text of the directive3 All these legislative texts can be found at httpeceuropaeuinternal_marketfinancescommit-

teesindex_enhtm4 httpeuropaeurapidpress-release_MEMO-12-656_enhtmlocale=en5 httpeuropaeurapidpress-release_IP-12-953_enhtmlocale=en6 httpeuropaeurapidpressReleasesActiondoreference=MEMO12129ampfor-

mat=HTMLampaged=1amplanguage=ENampguiLanguage=en]

ReferencesAktas C and Cortuk O 2012 Turkeyrsquos experience with the global crisis restructuring policies

within a financial stability framework Journal of Economic Policy Reform 15 (3) 195ndash205Baker A 2012 The new political economy of the macroprudential ideational shift New Political

Economy iFirstBasel Committee on Banking Supervision 2010a Basel III A global regulatory framework for

more resilient banks and banking systems DecemberBasel Committee on Banking Supervision 2010b Basel III International framework for liquidity

risk measurement standards and monitoring DecemberBroby D 2012 The regulatory evolution of the post credit crisis fund management industry

Journal of Economic Policy Reform 15 (1) 5ndash11Brunnermeier M Crockett A Goodhart C Persaud AD Shin HS 2009 The fundamental

principles of financial regulation Geneva Reports on the World Economy 11

28 L Quaglia

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

crisis Set against the benchmarks outlined in the introduction it is possible to concludethat despite the new pieces of legislation adopted by the EU the framework for financialservices regulation and supervision in the EU is not substantially different from the pre-crisis one The main obstacles to more far-reaching reform were political not economic

The EU is generally a slow moving institution and tends to be reactive rather thanproactive It took the Commission more than three years and several rounds of consulta-tion to come forward with a formal legislative proposal for a banking resolution regimeNegotiations in the Council and EP have just started and are likely to be time consumingThe DGS directive officially proposed by the Commission in 2010 has not yet beenagreed The proposed Banking Union would represent quite a major reform Yet it is farfrom being agreed and political discussions are ongoing

The Commission is also trying to grapple with structural issues concerning the bank-ing sector in the EU In February 2012 it appointed a High-level Expert Group headedby Erkki Liikanen (former governor of the central bank of Finland) to examine structuralreforms that would directly affect the structure of individual banks and the market as awhole (High Level Expert Group 2012)6 Such reforms could for example includeprohibiting banks from carrying out some activities such as proprietary trading (asenvisaged in the Dodd-Frank act in the US) or requiring banks to ring-fence theirdeposit-taking activities from investment banking as proposed by the IndependentBanking Commission in the UK In this case as well the jury is still out

AcknowledgementsThe author wishes to acknowledge financial support from the European Research Council (204398FINGOVEU) and the British Academy (SG 120191) This paper was written while the author wasa visiting fellow at the Max Planck Institute the European University Institute and HanseWissenschaftskolleg

Notes1 httpeuropaeurapidpressReleasesActiondoreference=MEMO12416ampfor-

mat=HTMLampaged=0amplanguage=ENampguiLanguage=en2 Sweden has a significant private equity industry hence it was seen as having a vested interest

in the revision of the text of the directive3 All these legislative texts can be found at httpeceuropaeuinternal_marketfinancescommit-

teesindex_enhtm4 httpeuropaeurapidpress-release_MEMO-12-656_enhtmlocale=en5 httpeuropaeurapidpress-release_IP-12-953_enhtmlocale=en6 httpeuropaeurapidpressReleasesActiondoreference=MEMO12129ampfor-

mat=HTMLampaged=1amplanguage=ENampguiLanguage=en]

ReferencesAktas C and Cortuk O 2012 Turkeyrsquos experience with the global crisis restructuring policies

within a financial stability framework Journal of Economic Policy Reform 15 (3) 195ndash205Baker A 2012 The new political economy of the macroprudential ideational shift New Political

Economy iFirstBasel Committee on Banking Supervision 2010a Basel III A global regulatory framework for

more resilient banks and banking systems DecemberBasel Committee on Banking Supervision 2010b Basel III International framework for liquidity

risk measurement standards and monitoring DecemberBroby D 2012 The regulatory evolution of the post credit crisis fund management industry

Journal of Economic Policy Reform 15 (1) 5ndash11Brunnermeier M Crockett A Goodhart C Persaud AD Shin HS 2009 The fundamental

principles of financial regulation Geneva Reports on the World Economy 11

28 L Quaglia

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

Buckley J Howarth D 2010 Internal market gesture politics Explaining the EUs response tothe financial crisis Journal of Common Market Studies Annual Review 48 (s1) 119ndash141

Buckley J Howarth D Quaglia L 2012 Internal market the ongoing struggle to lsquoprotectrsquoEurope from its money men Journal of Common Market Studies Annual Review 50 (s1)119ndash141

Carmassi J Gros D and Micossi S 2009 The global financial crisis causes and cures Journalof Common Market Studies 47 (5) 977ndash996

Commission of the European Communities 2009 Recommendation on Remuneration Policies inthe Financial Services Sector 2009384EC 30 April

Commission of the European Communities 2010a Directive on Deposit Guarantee Schemes[recast] 12 July

Commission of the European Communities 2010b Directive amending Directive 979EC oninvestor compensation Schemes 12 July

Commission of the European Communities 2010c White Paper on Insurance Guarantee Schemes12 July

Commission of the European Communities 2010d Proposal for a Regulation on OTC derivativescentral counterparties and trade repositories 15 September

Commission of the European Communities 2011a Proposal for a Directive on the Access to theActivity of Credit Institutions and the Prudential Supervision of Credit Institutions and Invest-ment Firms 2011453EC 20 July

Commission of the European Communities 2011b Proposal for a Regulation on PrudentialRequirements for Credit Institutions and Investment Firms 2011452EC 20 July

Commission of the European Communities 2012a Proposal for a Council Regulation conferringspecific tasks on the European Central Bank concerning policies relating to the prudentialsupervision of credit institution COM(2012) 511 final Brussels 12 September

Commission of the European Communities 2012b Proposal for a directive establishing a frame-work for the recovery and resolution of credit institutions and investment firms and amendingBrussels COM(2012) 2803

Council of Ministers and European Parliament 2009 Regulation (EC) No 10602009 of 16 Sep-tember 2009 on credit rating agencies

Council of Ministers and European Parliament 2011 Directive on Alternative Investment FundMangers

De Larosiegravere Group 2009 The High Level Group on Financial Supervision in the EU 25 Febru-ary Brussels

Dyson K and Quaglia L 2010 European economic governance and policies Volume II com-mentary on key policy documents Oxford Oxford University Press

Euroarea Summit Statement 29 June 2012 BrusselsFinancial Services Authority 2009 The Turner Review a regulatory response to the global bank-

ing crisis London MarchGroup of Thirty 2009 Financial reform a framework for financial stability Washington DC

Group of ThirtyHardie I and Howarth D Forthcoming Varieties of financial capitalism Oxford Oxford Uni-

versity PressHelleiner E 1994 States and the reemergence of global finance from Bretton Woods to the

1990s Ithaca Cornell University PressHigh-level Expert Group on Reforming the Structure of the EU Banking Sector 2012 Mandate

httpeceuropaeuinternal_marketbankdocshigh-level_expert_groupmandate_enpdfHowarth D and Quaglia L Forthcoming Economic governance and the political economy of

new capital requirements in the European Union Journal of European IntegrationKrugman P 2012a Austerity and growth New York Times 18 FebruaryKrugman P 2012b European crisis realities New York Times 25 FebruaryInternational Monetary Fund (IMF) 2011 Staff Report for the 2011 Article IV Consultationmdash

Supplementary Information No 11220Moschella M 2011 Getting hedge funds regulation into the EU agenda the constraints of agenda

dynamics Journal of European Integration 33 (3) 251ndash266Muumlgge D 2011 The European presence in global financial governance a principal-agent perspec-

tive Journal of European Public Policy 18 (3) 383ndash402

Journal of Economic Policy Reform 29

Dow

nloa

ded

by [

Bra

ndon

Uni

vers

ity G

ST]

at 0

950

14

Apr

il 20

13

Pagliari S 2011 Who governs finance The shifting public-private divide in the regulation ofderivatives rating agencies and hedge funds European Law Journal 17 (6) 44ndash61

Pagliari S 2012 A wall around Europe The European regulatory response to the global financialcrisis and the turn in transatlantic relations Journal of European Integration iFirst

Pauly L 2009 The old and the new politics of international financial stability Journal of Com-mon Market Studies 47 (5) 955ndash975

Quaglia L 2009 The politics of regulating credit rating agencies in the European Union Workingpaper of the Centre for Global Political Economy at the University of Sussex N 5 June

Quaglia L 2011 The lsquooldrsquo and lsquonewrsquo political economy of hedge funds regulation in the Euro-pean Union West European Politics 34 (4) 665ndash682

Quaglia L 2012 The lsquooldrsquo and lsquonewrsquo politics of financial services regulation in the EuropeanUnion New Political Economy 17 (4) 515ndash535

Quaglia L Eastwood R and Holmes P 2009 The financial turmoil and EU policy cooperation2007ndash8 Journal of Common Market Studies Annual Review 47 (1) 1ndash25

Royo S Forthcoming The global crisis and the Spanish financial system what can we learnGovernance at proof stage

Woll C 2012 The defense of economic interests in the European Union a strategic analysis ofhedge fund regulation In R Mayntz ed Crisis and control institutional change in financialmarket regulation Frankfurt aM Campus 195ndash209

30 L Quaglia

Dow

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ded

by [

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ndon

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ity G

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at 0

950

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Apr

il 20

13