Tuesday, September 22, 2009

A Tepid Compromise: The EU proposed three bodies to regulate and supervise finance

According to the latest proposals from the EU, three new pan-European supervisory agencies (one each for banks, insurers and securities markets) are to be created for the purpose for drawing up and helping enforce a common rulebook for each activity throughout the EU.

The bodies will have more powers and resources than the three existing EU committees, which play only a co-ordinating role.

What will weaken the ability of the proposed three bodies will be recognition of the principle of “fiscal responsibility”, meaning that the new supervisory structure must not intrude on states’ finances.

Why will it weaken these bodies? Because fiscal IRresponsibility by states is one key reason for irresponsibilty by individual companies as well as by the system as a whole.

In the event of a dispute with or between member states, there an appeal would be possible, ultimately to the European Council, where the final decision would be by qualified majority voting. This makes the whole elaborate creation of these bodies subject to political rather than rational criteria.

Possibly, these proposals from the European Commission may be the best that can be managed at present, but it falls far short of what is needed.

What is needed? Two things: a single regulator and a (separate) single supervisor for the EU.

Why a single regulator for 3 different kinds of activities (banking, insurance and securities markets)? Because these three are converging - or one should say have increasingly converged, and will continue converging ever more, into a single seamless set of financial transactions. This is already largely the case, with the three activities being kept artificially separate for regulatory purposes in areas where these are kept separate (the UK and Switzerland, for example, already have one regulator supervising all three activities).

So why two separate bodies (one for rule-setting and one for rule-enforcement)?

Because rule-setting is and should be a different activity from rule-enforcement.

Naturally, learning from rule-enforcement should feed into the rule-setting process.

But that is better and more transparently done by two separate bodies than by a single one.

So much for the matter of the three bodies that are proposed.

Separtely, there is a proposal for a new “European Systemic Risk Board”, made up of representatives of central banks and financial supervisory groups from the 27 countries which constitute the EU.

I am glad that such a Risk Board is proposed. However, having the same people in the Risk Board as ultimately control the 3 bodies will do nothing to provide confidence in the risk assessments of the Board.

Morevoer, systemic risk in Europe cannot be separated from systemic risk in the USA or in Asia - the current challenges arise from systemic problems in the USA, and the next crisis will arise from challenges in Asia.

While a European Systemic Risk Board is better than no Board at all globally, it would be better for there to be a global board - and one along the lines that I proposed in my article in the New York Times Online ("DayBook" section) at the end of June this year. Sphere: Related Content

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