European System of Financial Supervision
The European System of Financial Supervision is a system of EU agencies that aims to ensure consistent and coherent micro- and macro-prudential financial supervision in the EU. It includes the national supervisors, the three European supervisory authorities (EBA, ESMA and EIOPA) and the European Systemic Risk Board. There is a separate fact sheet (‘Financial Services Policy’) on the material rules that apply to the financial sector. After the ESFS had been created, the European Central Bank, as part of the Single Supervisory Mechanism, was appointed to directly supervise the largest banks within the Banking Union (2.6.5). For the material rules that apply to the financial sector, see the fact sheet on the EU financial services policy (2.6.13).
Legal basis
The legal basis for the European System of Financial Supervision (ESFS) is as follows:
- Articles 114 and 127(6) of the Treaty on the Functioning of the European Union;
- Regulation (EU) No 1093/2010 of 24 November 2010 establishing a European Supervisory Authority (European Banking Authority), as amended by subsequent legislation;
- Regulation (EU) No 1094/2010 of 24 November 2010 establishing a European Supervisory Authority (European Insurance and Occupational Pensions Authority), as amended by subsequent legislation;
- Regulation (EU) No 1095/2010 of 24 November 2010 establishing a European Supervisory Authority (European Securities and Markets Authority), as amended by subsequent legislation;
- Regulation (EU) No 1092/2010 of 24 November 2010 on European Union macro-prudential oversight of the financial system and establishing a European Systemic Risk Board, as amended by subsequent legislation;
- Council Regulation (EU) No 1096/2010 of 17 November 2010 conferring specific tasks upon the European Central Bank concerning the functioning of the European Systemic Risk Board.
Background and objectives
The EU financial sector is subject to a regulatory and supervisory framework designed to promote financial stability and protect the customers of financial services. EU regulations set out the rules and standards by which financial institutions must abide. These material rules are dealt with in a separate fact sheet on the EU financial services policy (2.6.13).
This fact sheet deals with supervision, which is a process of oversight designed to ensure that financial institutions apply those rules and standards properly. Among other issues, the 2007-08 global financial crisis laid bare the need to improve and strengthen the European regulatory and supervisory architecture. Following the recommendations of the February 2009 report by the high-level group chaired by Jacques de Larosière on strengthening the European supervisory arrangements, the European System of Financial Supervision (ESFS) was introduced in 2010 and became operational on 1 January 2011. The ESFS consists of the national supervisors (the national competent authorities of the Member States), the three European supervisory authorities (ESAs) – namely the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA) – the Joint Committee of the ESAs, and the European Systemic Risk Board (ESRB).
The main objective of the ESFS is to ensure that the rules applicable to the financial sector are adequately implemented across the Member States in order to preserve financial stability, promote confidence and provide protection for consumers.
The ESFS is a system that combines micro- and macro-prudential supervision. The main objective of micro-prudential supervision is to reduce the probability and limit the impact of the failure of individual financial institutions. Macro-prudential supervision is concerned with the exposure of the financial system as a whole to common risks, and aims to limit its distress in order to protect the overall economy from significant losses in real output.
The 2007-08 global financial crisis demonstrated a lack of harmonisation in the rules applicable to the financial sector and a lack of coordination, cooperation and common culture among the national supervisors to ensure compliance with those rules. In response, the EBA, ESMA and the EIOPA were created to address these problems in their respective financial service sectors – banking, capital markets and insurance. These three micro-prudential authorities work together on cross-sectoral and horizontal issues in the Joint Committee of the ESAs. In addition, the global financial crisis demonstrated that the EU’s pre-crisis supervisory architecture had placed too much emphasis on the supervision of individual financial institutions, and too little on the macro-prudential aspects. The ESRB was therefore established, and was handed responsibility for the macro-prudential oversight of the EU financial system and the prevention and mitigation of systemic risk.
In the pursuit of building an EU capital markets union, and as part of a broader range of measures, a 2019 review of the ESFS framework concluded by amending the founding regulations of the ESAs and the ESRB. These amendments aimed to reinforce the powers, governance and funding of the ESAs. While the review failed to reform the ESAs’ funding, it did add some direct supervisory powers for ESMA and strengthened key coordination instruments such as the peer reviews and the Questions and Answers tool. Moreover, the governance of the ESAs was improved by ensuring a better handling of conflicts of interest of national representatives on the ESAs’ boards and strengthening the position of the chairpersons. The review also highlighted the coordinating role of the ESAs in new areas, such as financial technology (fintech) and sustainable finance, and lets the ESAs set common priorities for supervision.
Framework
A. Micro-prudential supervision
1. European supervisory authorities (ESAs)
The EBA, ESMA and the EIOPA are EU agencies with their own legal personalities and are represented by their respective chairpersons. The ESAs must act independently and only in the interests of the EU as a whole. They are accountable to Parliament and the Council for their actions.
The primary objective of the ESAs, as defined in their respective founding regulations (the ‘ESAs Regulations’), is to protect the public interest by helping to reinforce the stability and effectiveness of the EU financial system.
The ESAs contribute to the development of a single rulebook by drafting two types of technical standards (regulatory technical standards and implementing technical standards), which are adopted by the Commission (as delegated or implementing acts). With a view to enhancing supervisory convergence, they issue guidelines and recommendations and have certain powers in cases of breaches of EU law by national supervisory authorities, emergencies and disagreements between competent national authorities.
In its relevant sector of activity, each of the ESAs, in consultation with the ESRB, is tasked with developing criteria for identifying and quantifying systemic risk and devising an adequate stress-testing regime for the institutions within its purview. The ESAs also initiate and coordinate EU-wide stress tests to assess the resilience of financial market participants.
In each of the three ESAs, the Board of Supervisors is the main decision-making body and consists of the chairperson, the head of the competent supervisory authority in each Member State and one representative from each of the Commission, the European Central Bank (ECB), the ESRB and the other two ESAs.
a. European Banking Authority (EBA)
Originally based in London, the EBA relocated to Paris in June 2019. The purview of the EBA encompasses credit institutions, financial conglomerates, investment firms, payment institutions and e-money institutions. With regard to credit institutions, the EBA has the same functions with regard to their crisis management and resolution that it has with regard to their supervision; to this end, it hosts a separate committee composed of representatives of the national resolution authorities and the Single Resolution Board. Following the 2019 review, the EBA was also entrusted with preventing the financial system from being used for the purposes of money laundering and the financing of terrorism.
b. European Insurance and Occupational Pensions Authority (EIOPA)
The EIOPA’s seat is in Frankfurt am Main. It is primarily concerned with insurance and reinsurance undertakings, insurance intermediaries, financial conglomerates and institutions for occupational retirement provision (IORPs). It mainly contributes to the single rulebook on insurance and occupational pensions through the Solvency II and IORP legislation, respectively.
c. European Securities and Markets Authority (ESMA)
ESMA is located in Paris. Its purview covers capital markets and participants (exchanges, traders, funds, etc.). In the EU, ESMA has direct oversight and sole responsibility for the registration, supervision and sanctioning of credit rating agencies and trade repositories. It is also in charge of recognising third-country (i.e. non-EU-country) central counterparties and trade repositories, and certifying and endorsing third-country credit rating agencies.
2. Joint bodies
The Joint Committee of the ESAs (known as the Joint Committee) is responsible for overall and cross-sectoral coordination between the ESAs, with the aim of ensuring supervisory consistency. It is also responsible for the settlement of disputes between the ESAs on cross-sectoral matters.
The Board of Appeal is independent from the three ESAs and is responsible for appeals from parties affected by the decisions of the ESAs. The decisions of the Board of Appeal can be contested before the Court of Justice of the European Union.
3. Competent national supervisory authorities
Each Member State designates its own competent national supervisory authorities, which form part of the ESFS and are represented in the ESAs’ decision-making bodies.
B. Macro-prudential oversight – European Systemic Risk Board (ESRB)
The ESRB carries out macro-prudential oversight at EU level. Its objective is to prevent and mitigate systemic financial stability risks in the light of macro-economic developments. It is composed of a General Board, a Steering Committee, two advisory bodies (Advisory Scientific Committee and Advisory Technical Committee) and a Secretariat. The ECB provides analytical, statistical, administrative and logistical support to the ESRB. The President of the ECB is also the Chair of the ESRB.
C. Cooperation at various levels
Financial markets are complex, interconnected and increasingly globalised. Coordination and cooperation between the supervisory authorities in charge of the different entities and sectors, both within the EU and globally, is therefore key. In that context, the ESAs play an important coordinating role. The various entities within the ESFS also coordinate with international institutions – including at supervisory forums such as the International Organization of Securities Commissions (IOSCO), the Financial Stability Board (FSB) and the International Association of Insurance Supervisors (IAIS) – and with third-country supervisors.
Role of the European Parliament
As co-legislator, Parliament played an important part in setting up the founding legislation for the ESFS. The chairpersons and executive directors of the ESAs must be confirmed by Parliament. Parliament also has extensive information rights, e.g. it is entitled to receive the annual work programme, the multiannual work programme and the annual reports of the ESAs. In addition, Parliament may request opinions from the ESAs. It also votes on the discharge of the budget of the ESAs each year. Moreover, the chairpersons of the three ESAs appear annually in a public hearing before Parliament. Finally, Parliament has a scrutiny role as regards the measures adopted in developing the single rulebook, i.e. delegated acts (including regulatory technical standards) and implementing acts (including implementing technical standards).
For more information on this topic please see the website of Parliament’s Committee on Economic and Monetary Affairs.
Kai Gereon SPITZER / Maja Sabol