In Depth: Maximalism vs Minimalism? – Financial Sector Reform, Banking Union and the Internal Market
By Morris Schonberg
This is the third in a series of in depth pieces focusing on the legal framework underpinning the European Union’s single market, technically known as the internal market. The articles advocate reform and address the best ways to move forward to overcome present challenges and re-boost growth. The first article introduced the general foundations of the single market and the second article looked at public procurement and how to ensure value for money is delivered in the EU.
This final article in the series focuses on the EU’s financial services sector and how the latest reforms to promote stability in the banking sector, at both the UK and EU-level, balance with the legal status of the single market.
The financial services sector in the EU has, in recent years, been subject to a wave of frenetic reform. At the structural level, supervisory competence has shifted away from individual member states to the EU with the creation of three new authorities, the European Banking Authority, the European Securities and Markets Authority and the European Insurance and Occupational Pensions Authority. The financial system as a whole is overseen by the European Systemic Risk Board, which is responsible for macro-prudential oversight.
Plans are now also in motion for a far greater degree of integration among the eurozone member states. On 12 September 2012, the European Commission published legislative proposals under which the European Central Bank (ECB) is to assume the mantle of single prudential supervisor for the eurozone member states – the so-called “single supervisory mechanism”, the first step in an envisaged Eurozone banking union.
The single supervisory mechanism will not be applicable to non-eurozone EU member states, however it will affect UK banks in so far as they undertake cross-border business relating to the eurozone and establish branches in eurozone member states. Furthermore, the current proposals provide for the possibility of non-eurozone member states signing up to the regime by entering into “close cooperation” agreements with the ECB.
While it appears that the initiative for close cooperation will – at least formally – need to emanate from the non-eurozone member state concerned, it remains to be seen what kinds of dynamics may be at play in influencing non-eurozone member states to bring their banking systems within the regime.
The general transfer of competence up towards the EU on the structural level has also been reinforced by a tranche of new internal market financial regulation, harmonising requirements and standards across the EU. Earlier this year, on 15 May 2012 the European Council reached political agreement on the so-called “CRD IV package” (Capital Requirements Directive) which implements, amongst other things, the international standards on required bank capital agreed at the G20 level known as the Basel III agreement.
Furthermore, on 6 June 2012 the European Commission issued its proposal for a framework for bank recovery and resolution, which sets out the minimum “toolbox” that EU Member State authorities should be equipped with to intervene in managing banks in crisis.
However the situation in the Member States, and in particular in the UK, has not stood still. In 2010, the UK Government tasked the Independent Commission on Banking to devise proposals to promote stability and competition in the UK banking sector.
The Independent Commission issued its final report in September 2011 and in a White Paper released on 14 June 2012, the Government indicated which recommendations it intends to take up. These include the ring-fencing of vital banking services, such as the taking of retail deposits from wholesale and investment banking, and measures to improve banks’ loss-absorbency, including higher capital requirements and requirements for ‘bail-in’ debt.
In various areas, the Government’s reforms cover the same ground as those being negotiated at the EU-level. This may lead to the potential for conflicts, which largely depends on whether the EU-level reforms are based on a model of “maximum harmonisation” or “minimum harmonisation”. For instance, when the European Commission first issued the proposed CRD IV package, it was based on a model of “maximum harmonisation” or “total harmonisation” in that it set out uniform standards from which no deviation would be permitted.
This contrasts with “minimum harmonisation” which refers to the practice of harmonising national laws to a minimum standard but allowing Member States to set national laws at a higher standard (so long as such laws do not infringe any of the other EU Treaty rules, such as those ensuring the free movement of capital).
In some areas the EU CRD IV package and the UK proposals conflicted, interestingly, because the UK proposals were more stringent. For example, the UK proposals require banks to hold higher levels of capital, which would not have been permitted under the EU model of maximum harmonisation. This led to a clash which ended in the political compromise achieved by the European Council, whereby in an exception to the model of maximum harmonisation, Member States would be able to require their banks to increase their capital buffers up to 3% for all exposures (and up to 5% for domestic and third country exposures) beyond the agreed standard without clearing their decision through the European Commission.
By contrast, the European Commission’s proposed framework for bank recovery and resolution is based on a model of “minimum harmonisation”. It is therefore only required that the UK proposals must, at the very least, incorporate those powers provided for in the Commission’s framework, with the UK being given the leeway to include more far-reaching powers. While the potential for conflict is not entirely excluded (one potential flashpoint relates to the extent to which derivatives should be within the scope of the bail-in tool), it is more limited.
Given the burgeoning degree and scope of EU financial regulation, the debate between the merits of maximum and minimum harmonisation is something that will only increase in significance going forward. From a legal perspective, both approaches may have their shortcomings.
Article 114 of the Treaty on the Functioning of the European Union which is the legal basis for EU internal market regulation requires that regulations have, “as their object the establishment and functioning of the internal market“. This has been interpreted by the Court of Justice of the EU as meaning that any measure must, “contribute to eliminating obstacles [to free movement] and to removing distortions of competition”. The problem with minimum harmonisation is that depending on the scope of leeway allowed to Member States to surpass the agreed EU regulatory standard, it may envisage a persistently fragmented internal market comprising various distortions of competition.
On the other hand, given that maximum harmonisation is a far more intrusive form of regulation, in line with the principle of proportionality under Article 5 of the Treaty on European Union, it must only be resorted to when necessary to achieve the justifiable objectives of the legislation.
Clearly, minimum harmonisation is a more flexible form of regulation. It has the capacity to reflect the reality of legal and cultural heterogeneity between the Member States and also allows for a degree of regulatory competition within the EU, while preventing a race to the bottom as a minimum standard is ensured. On the other hand, it is only maximum harmonisation that ensures a truly level playing field in Europe, free of any distortions of competition that may be caused by disparities in regulation.
The question of which model is appropriate depends on the specific issue in question. For instance, where health issues are concerned, minimum harmonisation allows for the setting of a minimum level of protection, while allowing Member States to retain the ability to set a more rigorous standard if they deem fit. On the other hand, for various product packaging laws for example, it may be more important to simply set a single standard so that disparities in packaging requirements do not act as obstacles to the free movement of goods across the internal market.
The question of which model is appropriate for EU financial regulation can be an awkward one as such regulation tackles concerns that relate to both areas. On the one hand, establishing minimum standards is important to safeguard financial stability. On the other hand, given the mobility of capital, significant disparities in levels of protection are prone to exploitation in the form of regulatory arbitrage.
Moreover, the potential for negative consequences arising from disparities in financial regulation is arguably more severe than in any other areas of internal market regulation given such disparities have the potential to not only undermine internal market integration, but also financial stability. A uniform, or closely-aligned, approach across the EU may therefore be the preferred method, so long as the standard set is adequate.
Such an approach clearly informed the European Commission’s initial thinking in the context of its original CRD IV package. In the original proposals the Commission justified the policy choice of maximum harmonisation on the basis that, “[i]nappropriate and uncoordinated stricter requirements in individual Member States might result in shifting the underlying exposures and risks to the shadow banking sector or from one EU member state to another.” It remains to be seen whether the balance between flexibility and uniformity agreed in the European Council may still achieve this objective.