On 4 November 2014, the European Central Bank became the prudential regulator for all Eurozone banks under the Single Supervisory Mechanism. The SSM does not introduce another layer of substantive regulation but significantly changes the way in which prudential supervision is applied in practice within the Eurozone. The intent is to provide for more consistent and harmonized supervisory practices and standards within the Eurozone, which is an inherently difficult goal to achieve given local country complexities and the continuing need to rely on on-the-ground national regulators. The ECB will nonetheless have a powerful role in the supervisory landscape and will doubtless try to shape and steer supervisory culture going forward.

Introduction

On 30 September 2014, the European Central Bank ("ECB") published its Guide to Banking Supervision,1 which sets out practical guidance for banks falling within its new supervisory remit. The Guide builds on the ECB regulation published on 25 April 2014, which established a framework for cooperation within the Single Supervisory Mechanism ("SSM") between the ECB and national regulators (the "Framework Regulation").2 This note sets out key changes affecting Eurozone banks, including subsidiaries of international banking groups within the Eurozone. Prior to assuming its role, the ECB undertook a financial health check of Eurozone banks (the "Comprehensive Assessment"), a year-long project in preparation for the new structure. The findings of the ECB's Comprehensive Assessment were announced on 26 October 2014.3 The Comprehensive Assessment included not only an asset quality review but also a forward-looking stress test of the banks, covering 130 of the largest banks in the Eurozone as of 31 December 2013.

The Single Supervisory Mechanism

The banking and sovereign debt crises in the Eurozone highlighted the flaws of a unified monetary and currency Union without fiscal union and consistency of banking supervision. In response, in 2012 the European Commission called for the creation of a Banking Union. One of the key pillars of the Banking Union4 is the SSM, which was established to restore confidence in the financial stability of Eurozone banks and to temper the link between bank solvency and government debt. The SSM underpins the European Stability Mechanism ("ESM") and is a precondition for the ESM being able to recapitalise banks directly. The ESM was originally set up to provide only for the indirect recapitalisation of banks by means of a loan being granted to the relevant Member State. Under the SSM, certain key tasks of banking supervision fall to the ECB. The ECB will apply the substantive rules of prudential supervision affecting Eurozone banks – termed "credit institutions." These rules include directly applicable EU Regulations (e.g., CRR), including options that Eurozone and other participating Member States are able to exercise under such Regulations, national laws of the Member States transposing the relevant EU Directives (e.g., CRD IV) and technical standards required to be produced by the EBA under the CRD IV package. In effect, the ECB supplants the role of national Eurozone and opt-in banking supervisors who have ceded the vast bulk of their oversight responsibility to the ECB. The ECB is now of equal status within the EU supervisory context to other non-Eurozone national banking supervisors, such as the Prudential Regulation Authority in the UK. All 18 Member States5 whose currency is the Euro automatically participate in the SSM, so it covers at least the approximately 4,900 banks6 established in the Eurozone. Other EU Member States may choose to participate in the SSM by opting in through the regime of "close cooperation." Several other Member States have indicated that they are likely to become "participating Member States."7 The UK, Sweden and the Czech Republic will remain outside.

Significant and Less Significant Credit Institutions

The ECB now exercises direct supervision over all "significant" Eurozone credit institutions. Whether a credit institution is significant or not is generally determined on the basis of:

  • the total value of its assets;8
  • the importance of the credit institution to the economy of the country in which it is located or to the EU as a whole;
  • the significance of the credit institution's cross-border activities; and
  • whether the credit institution has requested or received public financial assistance from the ESM or its predecessor, the European Financial Stability Facility ("EFSF").

The three largest credit institutions of each participating Member State are considered "significant" regardless of their absolute size. All other – "non-significant" – credit institutions are supervised by national regulators, albeit under the ECB's oversight, unless the ECB elects to assume the direct supervision of a particular credit institution. According to the lists published by the ECB on 4 September 2014,9 120 banking groups (representing approximately 1,200 supervised entities) were intended to be regarded as "significant" at inception of the SSM. These credit institutions account for almost 85 per cent of total banking assets in the Eurozone. The ECB will receive all information and reporting for significant entities through the national regulators, who are responsible for passing that information to the ECB. For less significant credit institutions, the ECB may issue general instructions and guidelines to national regulators to ensure consistent outcomes, but may also require a national regulator to adopt a supervisory decision for a specific institution, groups or categories of credit institutions. The ECB is expected to take concrete steps to harmonise standards and practices across the banks within the SSM. An early indication of the ECB's efforts on this front was set out in proposals to ensure financial reporting is carried out by all banks on both a solo and consolidated basis. 10

Role of the EU Supervisory Authorities

The SSM is intended to fit within the still new European System of Financial Supervision ("ESFS")11, which comprises the European Systemic Risk Board ("ESRB"), three European Supervisory Authorities ("ESAs")12 and the national regulators. There may, as a result, be some degree of overlapping supervisory responsibilities and duplicative requirements imposed on banks. The ESRB The ESRB has no direct powers over institutions and is tasked with macro-prudential oversight of the EU system, including identifying systemic risk concerns. This overlaps slightly with the ECB's remit, save that the ECB only covers participating Member States whereas the ESRB is responsible for the entire EU; and the ECB only covers credit institutions, whilst the ESRB's remit covers the EU financial system as a whole, including non-bank sectors and cross-sectoral concerns. The ESRB can only issue warnings and recommendations (on an "act or explain" basis) to the Union as a whole, or one or more of the Member States, or to the ESAs or national regulators. Warnings and recommendations can be issued to the ECB in the same way as to any other supervisory authority.

The European Banking Authority ("EBA")

The main decision-making body of the EBA is the Board of Supervisors13, which comprises, essentially, the 28 EU national regulators. There have been concerns that the EBA might become dominated by supervisors from SSM-participating Member States under the leadership of the ECB. To address this, voting provisions have been amended so that they generally require a "double majority" from authorities of both participating and non-participating Member States.14 The ECB will likely seek to coordinate among the bank regulators of participating Member States.

  • The main task of the EBA is to develop a single set of harmonised prudential supervisory rules throughout the EU in certain regulatory areas subject to harmonization ("Single Rulebook"), in particular through the issue of technical standards and guidance. Such Level 2 and 3 measures bind the ECB in the same way as for any other national non-Eurozone regulator.
  • The EBA issues a European supervisory handbook covering the EU as a whole in order to promote a common supervisory culture and best supervisory practices. The ECB will have its own more detailed supervision manual covering the supervisory approach within the SSM, which will take the form of an internal document addressed to SSM staff. Both the EBA and the ECB will seek to ensure that these two documents are consistent.
  • The ECB has also prepared a Guide to Banking Supervision, a publicly available tool which will be regularly updated to reflect developments in supervisory practice. The Guide addresses: (i) supervisory principles of the SSM, which comprise the use of best practices, the principles of integrity and decentralisation, homogeneity within the SSM, consistency with the Single Market, independence and accountability, a risk-based approach, proportionality, adequate levels of supervisory activity for all credit institutions and effective and timely corrective measures, (ii) the functioning of the SSM, including the apportionment of tasks between the ECB and the national regulators, decision-making processes, and the operating structure and supervisory cycle of the SSM, and (iii) the supervisory processes of the SSM. The Guide to Banking Supervision is not a legally binding document and is not a substitute for the EU Regulation establishing the SSM ("SSM Regulation"),15 the Framework Regulation or any other EU acts which provide for the legal basis of the SSM.
  • The EBA will continue to carry out EU-wide stress tests. Stress tests are also part of the ECB's toolbox within the SSM. Following the asset quality review and initial stress tests conducted in connection with the launch of the SSM,16 the ECB is expected to carry out its own stress tests on a regular basis. Key ECB officials have announced that these stress tests will be conducted in close cooperation with the EBA, in particular with regard to design and timing. There will be much less interaction between the ECB and the European Securities and Markets Authority ("ESMA") or the European Insurance and Occupational Pensions Authority ("EIOPA") as their respective areas of responsibilities will generally remain outside the scope of the SSM. Important exceptions are bank-led financial conglomerates (containing both banking and insurance businesses) for which supplementary supervision might be carried out by the ECB. The required cooperation will be addressed in a memorandum of understanding between the ECB and EIOPA.

National Regulators

National banking regulators in participating Member States remain in charge of all supervisory tasks falling outside the scope of the SSM. Areas such as consumer protection, money laundering prevention, payment services, conduct of business regulation and the special regimes for covered bond banks and building societies will remain with national regulators. This position will also apply for national legislation that goes beyond minimum European standards.

A Joint Supervisory Team ("JST") consisting of an ECB representative and relevant national regulators will be established for each significant credit institution. Although each JST will be led by a designated ECB staff member (who, as a rule, will be of a different nationality than that of the supervised institution) and includes staff members of national regulators of other participating Member States, the effectiveness of day-to-day supervision will largely depend on the support of the home state regulator. The JST set-up does not apply to less significant credit institutions. The allocation of responsibilities between the ECB and the national regulators is based on the Framework Regulation and is summarized in the table below. While the ECB will be at the forefront, it will undoubtedly have to make use of the local knowledge and expertise of national regulators. It will be challenging for the ECB to understand, construe and apply national law concepts across multiple jurisdictions. Where regulatory requirements derive from EU directives or as the result of the exercise of a national option available to participating Member States under EU regulations, the ECB will have to determine how these requirements have been transposed into the relevant national laws. Even if regulatory requirements are expressly spelt out in EU regulations or technical standards, they are embedded in the framework of national legislation of the Member States. Additional difficulties arise from the multiple European languages in which the approximately 6,000 credit institutions subject to the SSM conduct their businesses. National regulators will therefore continue to play a significant role. In jurisdictions where the national regulators have a long-standing administrative tradition and the regulatory process is generally established by precedent, the SSM is likely to take quite a while to become fully operational.17

Credit Institutions Established Outside the SSM

Credit institutions established in a non-participating Member State seeking to establish a branch or provide cross-border services in a Eurozone Member State or a state which has signed up to ECB oversight of banking regulations will continue to benefit from the EU passport regime (inbound passport). The ability of such banks to continue to operate in this way will not be greatly affected by the SSM. Going forward, the ECB must be notified of any requests for a passport to do business in a participating Member State. In relation to branch supervision, the powers of the host supervisor will be exercised by (i) the ECB for significant branches; and (ii) the relevant national regulator for less significant branches. For the provision of cross-border services, the powers of the host supervisor will be exercised by the ECB regardless of the significance of the relevant entity. For a credit institution established in a country outside the EEA18 (a "Third Country") seeking to establish a branch or provide cross-border services in a Member State, neither the EU passport regime nor the SSM will apply, regardless of whether the Member State participates in the SSM or not. Instead, the national laws of the Member State will govern the ability of such banks to branch into that Member State. A banking subsidiary of a Third Country institution established in a Eurozone or other participating Member State will be subject to the SSM. Under the SSM, the ECB will join cross-border supervisory colleges and co-ordinate the supervision of cross-border groups with supervisory authorities outside the SSM on the basis of memoranda of understanding.

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Footnotes

1 ECB, Guide to Banking Supervision, September 2014, available at: https://www.ecb.europa.eu/pub/pdf/other/ssmguidebankingsupervision201409en.pdf?85e39f5cf761e11147f6e828cd4088b1.

2 Regulation (EU) No 468/2014 of the European Central Bank of 16 April 2014 establishing the framework for cooperation within the Single Supervisory Mechanism between the European Central Bank and national competent authorities and with national designated authorities (SSM Framework Regulation) (ECB/2014/17).

3 See the ECB press release available at: http://www.ecb.europa.eu/press/pr/date/2014/html/pr141026.en.html. The ECB has also launched a new website, available at: https://www.bankingsupervision.europa.eu/home/html/index.en.html .

4 The other components of the Banking Union, i.e. the Single Rulebook, the Single Resolution Mechanism ("SRM") and a common deposit protection regime, are not addressed in this memorandum.

5 As Latvia adopted the Euro on 1 January 2014, it is also part of the SSM.

6 Only credit institutions within the meaning of CRR are subject to the SSM.

7 In particular, Romania, Denmark and Bulgaria. Other Member States have taken a "wait and see" approach and will stay out of the SSM for the time being. Lithuania will join the Eurozone and, consequently, the SSM on 1 January 2015.

8 If the total value of the credit institution's assets exceeds EUR30 billion or

9 ECB, The list of significant supervised entities and the list of less significant institutions, latest update of the list: 04/09/2014 (https://www.ecb.europa.eu/pub/pdf/other/ssm-listofsupervisedentities1409en.pdf?59d76de0c5663687f594250ebf228c6b).

10 The current supervisory financial reporting requirement, as set out on the technical standards on supervisory reporting under the Capital Requirements Regulation, only applies to banks applying International Financial Reporting Standards at a consolidated level.

11 For further information about the ESFS you may refer to Client Publication dated 18 October 2010 "The New EU Financial Supervisory Architecture" ( http://www.shearman.com/~/media/Files/NewsInsights/Publications/2010/10/The-New-EU-Financial-Supervisory-Architecture/Files/View-full-memo-The-New-EU-Financial-Supervisory-__/FileAttachment/FIA101810TheNewEUFinancialSupervisoryArchitecture.pdf).

12 The ESAs are the European Banking Authority ("EBA") with responsibility for the banking sector, the European Securities and Markets Authority ("ESMA") with responsibility for the securities sector and financial markets and the European Insurance and Occupational Pensions Authority ("EIOPA") with responsibility for the insurance and occupational pensions sectors. The Joint Committee of the ESAs is designed to foster coordination amongst the three ESAs.

13 Not to be confused with the newly established Supervisory Board of the ECB which is responsible for preparing ECB's decisions on supervisory matters.

14 Regulation (EU) No 1022/2013 of the European Parliament and of the Council of 22 October 2013 amending Regulation (EU) No 1093/2010 establishing a European Supervisory Authority (European Banking Authority) as regards the conferral of specific tasks on the European Central Bank pursuant to Council Regulation (EU) No 1024/2013.

15 Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions.

16 See the ECB press release available at: http://www.ecb.europa.eu/press/pr/date/2014/html/pr141026.en.html.

17 In contrast to EBA's conflict resolution mechanism, the Framework Regulation provides no solution for resolving potential disputes within the JSTs or potential conflicts on competence between ECB and national regulators in connection with the SSM.

18 It is expected that credit institutions established outside the EU, but within the EEA wishing to establish a branch or provide cross-border services in a Member State participating in the SSM will be treated in the same way as credit institutions established in a Member State not participating in the SSM.

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