Over the course of the week, ECB officials made considerable news by vocally pushing for greater EU-level supervision of Continental capital markets as Brexit progressed. Expect such calls to grow louder, and to continue far after London’s divorce from Europe is finalized.
The reasons are as much geostrategic as they are prudential. London’s membership in the European Union historically enabled it to act as a kind of speed bump slowing the progression of Brussels’ regulatory authority. As an economy reliant on capital markets, the United Kingdom’s priorities not infrequently diverged from those of Germany and France, where banks have driven finance, and it acted in ways to prevent prescriptive rules that could undermine its status as a premier financial center. But with Great Britain poised to leave, the overwhelming balance of power will shift to countries with larger banking (and bank-dependent) financial systems. A less risk-tolerant approach to speculation will be inevitable, as will a greater emphasis on price and financial stability.
ESMA (and the EBA, OIPA) WILL BE BIG WINNERS
Thus far, officials have, not surprisingly, focused on Brexit and banking. Loopholes that in effect allow participants to arbitrage local banking and investment management rules by establishing themselves outside the EU and setting up local branches will likely be closed. And with the continued development of the EU Capital Markets Union, there will also be a renewed drive to heighten oversight of securities and derivatives markets and market participants.
The big winners (from, at least an administratiave perspective) will be the former Lamfalussy committees. Indeed, European Commission Vice President Valdis Dombrovskis recently noted at last week’s annual Eurofi conference that:
“We can go further on the path toward supervisory convergence by empowering the European Securities and Markets Authority (ESMA) to directly supervise certain firms,” Dombrovskis said, adding he will propose that banks help pay for their supervision by regulators like ESMA.
And that’s not it—fintech will also make it to the regulators’ to-do list. Specifically, the Commission reportedly foresees “a ‘strong role’ for ESMA and its banking and insurance counterparts in the fintech sector as it seeks to compete with rival centers in London and elsewhere.” Along these lines, the EU would coordinate “national technological innovation tools like innovation hubs and regulatory sandboxes,” and in the process oversee the development and supervision of the sector.
Students of EU regulatory history should not be terribly surprised at Europe’s interest in fintech. The creation of ESMA, EIOPA and EBA was in part predicated on a stronger involvement by EU authorities in financial regulation. Getting the committees operationalized has, however, been slow—in part due to concerns involving national concerns and legacy regulatory regimes. But fintech could accelerate things: because fintech involves novel applications of technology and financial services, it provides authorities with the opportunity to address matters of first impression. As such, their choices won’t undermine established national regulatory approaches (though they could of course have implications for choices made in mature sectors).
Fintech is also a sector where prudential and financial economies of scale matter. Fintech invariably develops in the gaps or ‘interstices’ of established sectors like banking and securities, and can escape necessary supervision and oversight. As a result, coordination between sectoral authorities—and within sectors—will be necessary as firms embed themselves in systemically important financial systems. Centralized authority would reflect this reality. Moreover, coordination allows authorities to avoid the ‘race to the bottom’ feared in other sectors of European finance while at the same time provides market participants with common rules of the road that allow them to enjoy economies of scale across borders.
Indeed, it’s these benefits which lead me to wonder whether or not the potential consolidation of EU oversight could ultimately add to the already significant Brexit-related pressures facing the British financial services industry. EU-level supervision could induce more firms to consider establishing in Europe, as opposed to the United Kingdom, in order to operate throughout the region—and it could bolster Brussels’ power to project its own policy preferences abroad (and especially to London) where other jurisdictions seek eased access to Continental markets.