Blog Post

Brexit should drive integration of EU capital markets

Brexit offers EU-27 countries a chance to take some of London’s financial services activity. But there is also a risk of market fragmentation, which could lead to less effective supervision and higher borrowing costs. To get the most out of Brexit, the EU financial sector needs a beefed up ESMA.

By: and Date: February 24, 2017 Topic: Finance & Financial Regulation

London occupies a central role in the European financial system. Brexit will therefore generate significant risks and opportunities for the financial system of the remaining members of the European Union (EU-27). To successfully manage the resulting shifts, the EU-27 needs to adapt its financial regulatory structure. And with Britain’s departure from the EU single market nearly certain to occur before mid-2019, the EU-27 should not wait.

The main risks relate to the supervision of wholesale activities of financial firms and capital markets. Many wholesale market activities will need to be relocated from the United Kingdom to the EU-27 so that financial firms can keep serving local customers within the single market. To address these risks, European leaders should reinforce the European Securities and Markets Authority (ESMA) with significant additional resources and expanded responsibilities.

Market disruption is not the main risk for the EU-27’s single market. Most market participants have enough time to prepare for the worst-case scenario that there is still no agreement on “B-day” in early 2019. Rather, the main risk is market fragmentation along national lines with the loss of the London hub. Such fragmentation could result in less effective market supervision than is currently achieved by the UK authorities, a higher likelihood of misconduct and systemic disturbances, and a more onerous cost of funding for EU-27 corporates and households.

Fortunately, and thanks to wide-ranging reforms introduced during the past years of crisis, the EU-27 is much better equipped to face these challenges than it would have been a decade ago. All euro-area banks are now supervised on the prudential side by the European Central Bank (ECB), directly for the larger ones and indirectly for the smaller ones. This minimises the possibilities of regulatory arbitrage and of a concentration of systemic risk in a given country.

However, the ECB has no jurisdiction on important arenas of market activity and regulation. These include securities firms (also known as broker-dealers), asset managers and financial infrastructure such as central counterparties (CCPs, also known as clearing houses). The ECB also does not cover the conduct-of-business oversight of banks themselves.

ESMA was created in 2011 to help foster “supervisory convergence” and mitigate the vast existing differences of approaches, experience, and effectiveness between individual member states’ national authorities (such as BaFin in Germany, AMF in France, and Consob in Italy). ESMA also has some direct supervisory authority, but only over comparatively tiny market segments, namely credit rating agencies and trade repositories. ESMA has built up a decent track record, but its current mandate is not sufficient to integrate EU-27 capital markets and ensure high standards of compliance with EU regulations.

The obvious solution is to enhance ESMA’s responsibilities, especially over those wholesale market segments which are currently concentrated in London and which require uniform, high quality supervision. We recommended expanded responsibilities that include

  • authorisation of significant investment intermediaries (for example banks and securities firms) under the EU Markets in Financial Instruments Directive and Regulation (MiFID/MiFIR);
  • registration, supervision, and resolution of CCPs, at least those that serve international clients and have a potentially systemic importance from an EU perspective;
  • supervision of audit firms and the enforcement of International Financial Reporting Standards.

In parallel, the governance and funding of ESMA should be overhauled to better suit an enhanced scope of authority. Its current supervisory board, in which only representatives from national authorities have a vote, should be reformed to include an executive board of, say, five or six full-time members vetted by the European Parliament, as is the case with the ECB and the recently created Single Resolution Board. And in line with international best practices, ESMA’s funding should rely on a small levy on capital markets activity under scrutiny from the European Parliament, instead of the current political bargaining through the general EU budget.

Moreover, ESMA should be the single EU-27 point of contact for all interaction with third-country (non-EU) authorities. It should represent the EU-27 securities regulatory community in international supervisory colleges wherever relevant, and in international standard-setting bodies such as the International Organization of Securities Commissions and the Financial Stability Board. It should also, importantly, be given oversight authority over non-EU financial infrastructure that is systemically important for the European Union, similar to what already exists in the United States. This would allow flexibility in handling the financial stability challenges linked to the location of derivatives transactions, especially those denominated in euros, without having to force a costly relocation of their clearing in the euro area in the short term.

These reforms are significant but can all be achieved within the current treaty framework and without having to wait for the actual UK exit. They would all take the form of Internal Market legislation approved by a qualified majority vote. In fact, the United Kingdom can be expected to favour them all, for the same reasons it supported the inception of banking union in 2012–14: It is in the interest of the United Kingdom to have a well-regulated, well-supervised EU-27 financial system as its neighbor, for economic growth and financial stability reasons.

There is no compelling counterargument against financial market policy integration, especially now that the early achievements of banking union, including a broadly strong and effective European banking supervision led by the ECB, have provided a “proof of concept.” Significantly, the influential German Council of Economic Advisors (Sachverständigenrat) indicated in its latest annual report that “organising the supervision of banks, insurance companies and financial markets at [the] European level is the right approach.” The European Commission will review its signature policy of capital markets union in June: This should offer the perfect opportunity to announce the reinforcement of ESMA along the lines suggested above.

Other initiatives are also needed to make the best of Brexit for the EU-27 financial system. In particular, banking union is still an unfinished project that will need strengthening in order to better share the risks and benefits of the forthcoming relocation of financial activity from London. The distracting project of a European Financial Transaction Tax should be either reframed as a stamp duty on securities transactions or abandoned altogether.

Most importantly, leaders should make it clear that the inevitable competition among European financial centers to attract business from London should not be based on financial regulatory competition, but on other, non-regulatory factors such as infrastructure, skills, quality of life, as well as labour and tax legislation within the boundaries set by EU law. A swift move towards a stronger, more authoritative ESMA would be the best way to cement this vision.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic

Opinion

How a second referendum could be the best way to overcome Brexit impasse

A new vote based on the revocation (or not) of Article 50 would give the UK government a clear signal to proceed in one direction or another, and thus trim down the number of options being touted – most of which are unworkable as things stand.

By: Maria Demertzis and Nicola Viegi Topic: European Macroeconomics & Governance Date: December 14, 2018
Read article Download PDF More on this topic More by this author

Policy Contribution

Forecast errors and monetary policy normalisation in the euro area

What did we learn from the recent monetary policy normalisation experiences of Sweden, the United States and the United Kingdom? Zsolt Darvas consider the lessons and analyse the European Central Bank’s forecasting track record and possible factors that might explain the forecast errors.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 13, 2018
Read article Download PDF

Policy Contribution

European Parliament

A monetary policy framework for the European Central Bank to deal with uncertainty

In this Policy Contribution prepared for the European Parliament’s Committee on Economic and Monetary Affairs (ECON) as an input to the Monetary Dialogue, the authors review the emerging challenges to central banks, and propose an updated definition of price stability and an adequately refined monetary policy framework.

By: Grégory Claeys, Maria Demertzis and Jan Mazza Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: November 22, 2018
Read article More on this topic

Blog Post

Could Italian private wealth compensate for flight of foreign bond-holders?

Italy’s deputy prime minister Matteo Salvini is "convinced" that Italians can help out their government, in the face of a widening yield spread between German and Italian government bonds. The authors assess the feasibility of recourse to household wealth in Italy, and estimate the relative importance of foreign debt-holders in the upcoming bond redemptions.

By: Jan Mazza and Silvia Merler Topic: European Macroeconomics & Governance Date: November 19, 2018
Read article More on this topic More by this author

Blog Post

The Brexit withdrawal agreement

On November 14th the UK government cabinet approved the draft text of the withdrawal agreement, the deal reached between EU and UK negotiators. The decision was followed the next day by the resignations of several members of Parliament. We review the first reactions in the blogosphere.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: November 19, 2018
Read article More on this topic More by this author

Podcast

Podcast

Director’s Cut: Options yet open for a Brexit deal

Robin Niblett, director of Chatham House institute, joins Bruegel deputy director Maria Demertzis for an assessment of what progress can be reasonably expected from the final months of the Brexit negotiations.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: November 7, 2018
Read article More on this topic More by this author

Blog Post

Post-Brexit transfers of personal data: The clock is ticking

The UK government would like to keep EU-UK data transfers largely the same following the country's separation from the EU. But talks have yet to even commence on a future data-sharing relationship, and a landmark European Court of Human Rights ruling in September bodes poorly for the UK's future status under the EU’s General Data Protection Regulation.

By: J. Scott Marcus Topic: European Macroeconomics & Governance Date: November 7, 2018
Read article More on this topic More by this author

Podcast

Podcast

Director’s Cut: How to reform and fortify the global financial system

Bruegel director Guntram Wolff is joined by Tharman Shanmugaratnam, deputy prime minister of Singapore and chair of the G20 Eminent Persons Group, and Jean Pisani-Ferry, mercator senior fellow at Bruegel, for a conversation about the growth and stability challenges facing the global financial system, and how the system can be better equipped to deal with the significant and novel problems of the future.

By: The Sound of Economics Topic: Global Economics & Governance Date: October 23, 2018
Read article More on this topic More by this author

Blog Post

Digesting the Salzburg Summit

As the moment of truth for Brexit negotiations is approaching, with the October European Council around the corner, we review opinions on the outcome and meaning of the Salzburg summit.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: October 1, 2018
Read article More on this topic More by this author

Podcast

Podcast

Backstage: Brexit consequences for EU’s ICT policy

Bruegel senior fellow Scott Marcus welcomes former European Regulators Group chairman Kip Meek to explore the consequences of Brexit for ICT policy-making in Europe.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: September 25, 2018
Read article More by this author

Parliamentary Testimony

European Parliament

Brexit and industry & space policy

Testimony before the European Parliament's Committee on Industry, Research and Energy (ITRE).

By: Reinhilde Veugelers Topic: European Parliament, Innovation & Competition Policy, Testimonies Date: September 25, 2018
Read article More on this topic

Blog Post

The higher yield on Italian government securities could soon be a burden for the real economy

The increase in the spread between Italian (BTP) and German (Bund) government securities is directly an additional burden for Italy public finance, and thus for tax payers. But it could soon also become a burden for the real economy, as the increased yield on Italian government securities could pull up the cost of bank loans for Italian firms, thus imparting a deflationary impact onto the economy.

By: Francesco Papadia and Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: September 10, 2018
Load more posts