UK: The Role Of The European Commission In Financial Services Regulation

Last Updated: 10 June 2010
Article by Niamh Grogan and Dr. Gordon Christian

Originally published on www.complinet.com on June 3rd, 2010.

Most compliance professionals in the UK financial services industry will be focused on the increasing regulatory scrutiny that originates from the UK, including Peter Freeman's recent widely reported speech in which he examined the issues connected with a (as yet hypothetical) competition investigation of the UK banking sector. In his speech, Freeman noted that such an investigation undertaken by the Competition Commission could cover a wide range of banking services provided to personal and business customers, from lending and deposit-taking by high street banks to advisory and capital-raising services by investment banks. He went on to state that the investigation would need to go beyond an ordinary competition analysis to consider a broader range of issues, such as the effect of government intervention in the ownership of particular banks and the need to maintain financial stability.

It is also important to note that the European Commission is increasingly active both on the competition and on the regulatory side in terms of financial services, including:

  • Developments on interchange fees arising from the sector inquiry in 2007. The inquiry enabled the commission to examine the causes of market fragmentation and to highlight barriers to competition in retail banking. The commission concluded that widespread competition barriers existed within the sector which unnecessarily raised the cost of retail banking services in the single market. Following this, the commission announced that it would work with national competition authorities to open investigations, where necessary, into the areas of concern identified, such as product tying by banks holding dominant market positions, barriers and discriminatory rules in payment cards and payment systems markets and cooperation among banks resulting in barriers to entry.

    One such investigation that the commission opened at its own initiative was the formal investigation of Visa launched in March 2008. The investigation related to a suspected breach of Article 101 of the Treaty on the Functioning of the European Union relating to multilateral interchange fees set by Visa for cross-border point of sale transactions in the European Economic Area for debit card payments. The commission concluded that Visa's MIFs restricted competition between the merchant acquirers and, ultimately, contributed to inflated costs of payment card usage for both retailers and their customers. Visa has recently proposed measures to address the commission's concerns, which include reducing the MIF to 0.20 per cent of the final price of a product or service, which would constitute a 30 per cent reduction in charges on Visa debit cards. The commission has welcomed the proposals, which will undergo a market test before they can become binding. The proposals mirror an earlier agreement between the commission and MasterCard in April 2009. The agreements between the commission and Visa and MasterCard will aid the Single European Payment Area Project of the European Payment Council, which is supported by the commission. SEPA is a selfregulatory project based on cooperation between competitors, with the aim of creating effective and transparent payment markets.
  • Increased emphasis on sector specific regulation and supervision. Joaquin Almunia, the Competition Commissioner, has emphasised the importance of sector specific regulation and supervision in the financial services sector, where lack of effective regulation can lead to market failures with devastating effects. Citing the recent financial crisis as being demonstrative of the negative effects of a lack of supervision, he stated that current efforts to regulate financial institutions better include more appropriate capital requirements, better supervision and the creation of adequate resolution mechanisms.
  • The appointment of Michel Barnier as commissioner for internal market and services. In his role as internal market commissioner, Michel Barnier has a major role in regulating Europe's financial services industry. The campaign has seen the commission adopt legislative proposals to create European Supervisory Authorities which would regulate and supervise the financial markets, with an aim to improve confidence in the financial sector. The proposed authorities would work towards putting in place a single rulebook applicable across Europe, solving disagreements between national supervisory bodies, monitoring the correct application of EU law and intervening in emergency situations. Further proposed legislation is expected within the coming months and Michel Barnier has indicated that the commission will focus on urgent subjects that need intervention, such as the derivatives markets, short selling and credit default swaps.
  • Focus on auditors. The commission has announced that it will investigate the role of auditors, following questions raised by the role that Ernst & Young played in the collapse of Lehman Brothers. A green paper is expected to be published this autumn, which could eventually lead to more specific legislative proposals for tighter supervision. It is expected that the green paper will also cover issues such as international standards on auditing, the concentration in the audit market and its implications on financial stability.
  • Planned upfront levy on lenders. The commission has this week proposed that a new upfront levy is imposed on banks, creating funds to insure against future financial crises. The funds would not be used to bail out or rescue banks but to ensure that a bank's failure is managed in an "orderly way". The commission stressed that banks should not be allowed to pass the costs on to customers in higher charges. It is expected that the proceeds of the funds would remain within national borders, allowing regulators in each country to take measures to deal with insolvent banks. The proposals are to be discussed by EU finance ministers, heads of state and the G20, with the aim of legislating by 2011. According to recent press reports, UK chancellor George Osborne is in favour of a banking levy but believes that the national governments should have freedom to decide how the money is spent, rather than ring-fencing a fund to be held until an emergency arises.
  • Proposed supervision of credit rating agencies. The commission intends to centralise supervision of credit rating agencies and improve the transparency of their actions amid concerns that there is insufficient competition in the credit ratings market. Recent uncertainty in the financial markets has been blamed on the downgraded ratings of Greek and Portuguese debt. The proposals will seek to agree to one of the new pan-EU supervisory agencies to oversee credit rating agencies in Europe, with access to the agencies' methodologies and to information on past ratings. The commission hopes that these measures will be in place by the end of 2010.

An increase in regulation at European level will have a clear impact on competition authorities in the UK, requiring close cooperation between European regulators and UK competition authorities to ensure that consistency and continuity is achieved. One such authority, the Office of Fair Trading, has announced that it is to launch a review of barriers to entry, expansion and exit in retail banking. Given the recent change in the global banking industry, and the imminent entry of several new players to retail banking, the OFT wants to understand whether there are any hurdles facing new entrants and smaller banks seeking to expand. Findings from the review are due to be published by the autumn of this year. One of the possible outcomes of the OFT review is that the retail banking market is referred to the Competition Commission for an in-depth market investigation. Similarly to the European Commission, the Competition Commission has wide-ranging powers to remedy any issues it decides are detrimental to competition in markets under investigation, and these include structural remedies. It will be important, therefore, to keep a close eye on the regulatory scrutiny of the financial services industry from both EU and national competition authorities, as the current developments have the potential to reshape the industry significantly.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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