Capital Markets Union - An updated regulatory perspective - Gerry Cross, Director of Policy and Risk

26 April 2018 Speech

Central Bank of Ireland

Remarks delivered to the British Irish Chamber of Commerce Event, International Financial Services in Ireland and the UK in a post-Brexit world


Good morning. It is a great pleasure to be here. Many thanks to the British Irish Chamber of Commerce for the invitation.

I will focus my comments this morning on Capital Markets Union, and provide you a regulatory perspective on the project in general and where things have got to.

Then I would like to say a little bit about one or two of the challenges that I see ahead.

The benefits of a capital markets union from a regulator’s perspective.

The creation of a EU Capital Markets Union seeks to:

  • Improve the availability of and access to financing for businesses and infrastructure across Europe.
  • Increase and diversify sources of funding, resulting in enhance private risk sharing.
  • Enhance opportunities for investors.
  • Make markets work more effectively and efficiently especially across borders.

These are valuable goals and ones that at the Central Bank of Ireland we support – both in themselves and as the objectives of the CMU project.

Where are we now?

Capital Markets Union was always going to be a programme of incremental progress across a number of important of areas. It was never going to take the form of a big bang – nor even a sequence of smaller bangs. And nor should it. Deeper, better functioning capital markets are a cumulative, aggregative endeavour – one that takes time and ongoing effort to realise.

Much has already been achieved. Amongst other things, the new securitisation package, including the so-called STS (simple, transparent, standardised) securitisation framework has been agreed. As has the third Prospectus Directive. Under Solvency II, a new asset class of "qualifying infrastructure investments" has been developed and established.
2018 has seen an important phase of further activity which will bring the CMU project further. Amongst the initiatives currently under way are:

EU FinTech Action Plan

At the Central Bank of Ireland, we have recently announced the establishment of an Innovation Hub as part of a broader FinTech initiative. In this regard have a look at the speech at University College Cork last Friday of Derville Rowland, Director General for Financial Conduct. It is important that regulators are closely engaged with emerging developments in this field so that the benefits of innovation are realised for consumers and the economy. So we are supportive of the European Commission’s FinTech Action Plan which will drive a joined-up response at the European level.

Cross-border distribution of Investment funds proposal

The European Commission has published proposals to better facilitate the cross-border distribution of investment funds. The proposals seek to reduce regulatory barriers and streamline cross-border distribution in Europe. Amongst other things, it seeks to amend the UCITS Directive and the Alternative Investment Fund Managers Directive (AIFMD) to clarify provisions where a lack of clarity may have given rise to ‘gold plating,’ and to align the process under the UCITS Directive and AIFMD where AIFs are being marketed to retail investors. It also provides a definition of pre-marketing. The Central Bank is generally supportive of the proposal, though we believe that it could go further in some respects. 

Prudential Treatment of Investment Firms proposal

In December 2017 the Commission published proposals for a distinct prudential regime for investment firms. The Central Bank is generally supportive of such an approach. The proposals should, as long as they are well calibrated, lead to a set of requirements that are tailored to investment firm business models and hence appropriate to the risks that these firms pose to customers and to markets, while at the same time being proportionate and reducing the complexity of compliance for these firms.

Sustainable Finance

As part of the CMU’s efforts to connect finance with the specific needs of the European economy, the European Commission has recently published an Action Plan on sustainable finance. The aim of which is to embed sustainability considerations in financial and investment decision-making, and in doing so achieve the EU's 2030 climate and energy targets. This is a positive step. At the same time we must be sure to stay embedded in the risk-based approach which, as we have learned, is so important if we are to avoid another financial crisis.

These are just a few of the recent developments. And, of course, I could have discussed others – the very important proposal for a Pan European Personal Pension Product (PEPP) for one example, the Covered Bonds proposal which seeks to establish a more coherent regulatory definition of covered bonds at EU level based for another, or again the Commission’s work on Private Placements, amongst others.

But what is clear is that across a wide front the work is progressing well in line with - at least my - expectations. A good case of steady as she goes.

Challenges ahead

But it wouldn’t be a good regulatory speech if, having outlined the positives and the successes, I didn’t then lower my eyebrows and note that there are challenges ahead.

And there are indeed challenges ahead. Let me discuss three of them: (i) the UK’s imminent departure from the EU; (ii) the need to ensure that CMU is well-integrated in the global financial system; and (iii) the type of supervisory structure that is necessary in a Capital Markets Union.

Brexit and Capital Markets Union

Brexit makes the CMU project even more important while at the same time raising additional challenges.

Given the extent to which European capital markets currently have a significant centre of gravity in London, we will be further from achieving the benefits of a capital markets union post-Brexit than we were before. The goals remain as important as ever, but the distance from them will have increased. Therefore implementing the CMU becomes even more to be valued.

But doing also becomes more difficult. London is a significant repository of capital markets activity and of capital markets expertise. Forms of activity and expertise that cannot be done without. Within the EU27 either we will either need to replicate them or we will need to continue to access them in some form or other post Brexit.

To the extent that we wish to rely on continued access, rather than replication, then the regulatory perspective is that we will want to be sure that the financial services activities being carried out in the EU are subject to the norms and standards that the EU has set, that the risks of failures and damage are kept within the EU risk appetite, and that where failures do occur that losses are not inappropriately distributed. The same applies of course to those having regulatory responsibilities in the UK concerning the situation there.

Three approaches to cross-border financial services activity

In broad terms, we might identify three categories of possible approach to the interaction of the financial systems of the two jurisdictions. These might be described as (i) joint approaches, (ii) reciprocal approaches, and (iii) approval approaches.

The current approach is a good example of a joint approach. All parties come together to agree a common set of regulation. They agree mechanisms for joint determinations of disputes and uncertainties and they have in place enforcement mechanisms to ensure that all play be the common rules. From the financial regulator’s perspective this is a highly attractive approach. It allows for maximum flow of finance without compromising on either financial stability or accountability concerns. Let's assume for present purposes that such a joint approach, at least in its current configuration, is off the table.

By a reciprocal approach, we mean one whereby each jurisdiction recognises the regulatory framework of the other (or relevant parts of it), and provides access to its jurisdiction to firms falling to be regulated within that framework. An example is the proposal for a mutual access approach embedded in a Free Trade Agreement developed by the City of London’s and CityUK’s International Regulatory Strategy Group. Something similar has been proposed by UK Finance.

Based on the idea that we are starting from a very high level of consistency of regulatory frameworks, and from the proposition that increased barriers are both unnecessary and will result in significantly sub-optimal mutual outcomes, this work proposes mutual access on the basis of reciprocal recognition of each other’s framework. The potential for regulatory differences to emerge over time would be handled under a rubric of “managed divergence” whereby a mechanism would be established to assess the materiality of such divergence and where deemed material to determine an appropriate level of exclusion.

The third approach is what I have described as the approval approach. Under this approach each side reserves to itself the right to determine for itself, on an issue by issue basis, whether or not the regulatory and supervisory regime of the other is in line with its own framework. The current “equivalence” approach embedded in a range of EU financial services legislation is an example of this approach.

It is worth noting that while each of these approaches is conceptually distinct, they do not sit in clear mutual isolation from each other. Rather they are points on a continuum with the potential for other interim points along that spectrum to be identified.

The respective merits of each of these approaches in the context of Brexit are reasonably clear. Under a reciprocal approach there continues to be a high level of mutual access and disruption is kept to a minimum. Under an approval approach there is, from the perspective at least of the approving jurisdiction, a higher level of certainty and precision around the securing of respective regulatory objectives.

Each approach also has material deficits however. Under reciprocal approaches, the key challenge is around the question of the regulatory outcomes to be targeted or achieved. Given the extent to which, for example, UK financial services activities are integrated in the EU economy, it must be asked to what extent a focus on outcomes, even if defined in quite a detailed way, can be sufficient to ensure that one set of firms does not enjoy a competitive advantage over another.

As a regulator closely involved in the work of all three ESAs, I have a keen appreciation of how much the details of European rules and guidance matter. It really matters, to take a couple of hypothetical examples, whether the rules say “suitable” or “appropriate”, whether the relevant period is 75 days or 90 days, whether something is “required” or “expected”, and so on. So, it seems to me that a key challenge for any reciprocal approach is how to close the gap between a commitment to outcomes on the one hand and to rule-consistency on the other.

For approval approaches, on the other hand, it is the one-directional or unilateral nature of any approval-type system that is its biggest weakness. The fact that it relies on the determination of each side as to the compliance of the other, means that it has a potential instability that makes it more challenging to provide the high levels of future certainty that is important to financial sector participants and their customers. It also means that it does not have any inbuilt cohering dynamic or mechanism for fostering common approaches and trust between the two jurisdictions. This significantly increases the challenges in maintaining ongoing alignment.

As we enter the phase of negotiation around the future relationship arrangements between the EU and UK, being as clear as possible about different approaches and their advantages and disadvantages will be important. It may also be useful to consider the extent to which and how the weaknesses of the different approaches may be addressed in order to bring them closer to each other.

Ensuring an internationally integrated CMU

Let me say a few words about a related but separate issue. That is the challenge of ensuring that a European Capital Markets Union is grounded in a strong philosophy of openness and is well integrated into the global financial system. One of the risks of creating new unions is that you can also create new borders around them. This can happen by design or by accident, it can happen quickly or it can evolve over time. It is important that this risk is identified and resisted.

At the heart of any capital markets union is of course a belief that enhanced welfare outcomes can be achieved when capital is allocated and risk distributed in accordance with well-regulated market mechanisms.

A corollary of this is that, subject to the point about effective regulation, then the wider and deeper the market, the better will those mechanisms of allocation and distribution achieve their objectives. That should be the starting point.

But of course it remains the case that it is necessary to make sure that regulation and supervision are appropriately effective. So the question becomes how do you ensure that regulation is effective in a cross-border / third-country context. That is an important and difficult challenge. It is one that requires a great deal of focus and insightful attention. The question of the approach to delegation and outsourcing to third countries is one example of where this question arises.

If the right outcomes are to be achieved, it is very important that we are clear about, and stay sharply focused on, the objectives that we seek. If not there is the risk that what is both an important and difficult discussion becomes sidetracked and enmeshed in extraneous issues.

So in taking this work forward we need to remain strongly focused on the legitimate and important goals of financial regulation: financial stability, trust and confidence in the financial system, and consumer and investor protection. And it is important, particularly in the current challenging context, that we seek to avoid restrictions or barriers that go beyond those goals.

Supervision in a Capital Markets Union

Finally, let me say a few words about supervision in the context of a capital markets union. This is an area which is currently under discussion, for example in the context of the ESAs review.

Although they share a descriptor, Capital Markets Union is not the same as Banking Union. Of course they share many similar features, including a belief that enhanced integration in these contexts delivers better results in terms of the economic welfare of citizens. But one important difference is that under capital markets union there is not the imperative, that is there under Banking Union, to break the link between sovereigns and banks. And that of course is one of the main reasons why under Banking Union it was, and is, considered so necessary to have a single supervisor for the Union.

In respect of CMU therefore, unlike Banking Union, there is no material necessity to move towards a single supervisor.

What is necessary, and where progress is required, is further enhanced levels of consistency and convergence between supervisors, as well as further strengthened cooperation between national authorities.

Since the crisis, there has been a significant focus on building single rulebooks for the different sectors - banking, insurance and markets. This has been necessary, important and successful work. While a significant amount of work has also been done on supervisory convergence, and in fact it is often not recognised how much has been done in this regard, nonetheless it remains the case that this is an area where enhancement is needed over the next phase.

Similarly in respect of cooperation between home and host supervisors to ensure that the system works well. Here, once again, important progress has been made in the recent period - for example EIOPA’s 2017 Decision on cooperation and the firm-specific cooperation platforms that it operates in relevant circumstances, and ESMA’s Supervisory Coordination Network in respect of Brexit authorisations. And here again, the ESAs review represents an opportunity to embed some of these aspects further.

In doing so, however, great care must be taken not to muddy questions of authority and accountability, and not to introduce inefficiencies. It must be firmly avoided to in any way compromise the clarity of responsibility of national authorities in respect of their authorisation and supervisory mandates.


I will finish there.

In summary I have argued:

  • That the CMU is a very important project with the potential to deliver real benefits in terms of the economic welfare of European citizens.
  • That it is inevitably incremental, but the increments are mounting up and the landscape is changing for the better.
  • But that there are real challenges ahead. These include:
    • Finding the future partnership arrangements between the EU and the UK which will preserve the benefits of what has been built over the years while ensuring that financial stability and the application of relevant norms are achieved.
    • Ensuring that a Capital Markets Union results in a greater ability to benefit from global financial markets and not in one more boundary to be negotiated.
    • The ESAs review represents an opportunity to enhance the context of supervision for a capital markets union. Here the focus should be on convergence and cooperation and not laying the groundwork for a single supervisor or muddying the picture in respect of supervisory responsibilities.

Thank you for your attention.