The main EU regulatory to the financial crisis - Essay Example

The main EU regulatory to the financial crisis Introduction The financial crisis that rocked the European Union from 2007-2009 affected the economies largely because the mega financial institutions within Europe were operating in a similar business model to that of the United States prior to the crisis. Evidently, the financial crisis began in the second quarter of 2006 in United States. To this end, there were significant losses registered banks in United States as a result of sub primal foreclosures of mortgages (Chrisdoulaki, 2010). Consequently, since the mega banks in European Union and United States were operating under business models which were similar, the financial distress facing the United States were replicated in the European Union. To this end, the mega banks located on both the European Union and United States suffered from under-capitalization and insufficient liquidity reserves. Evidently, the financial regulations of the European Union are carried out at the continental level as well as within the individual countries. The European regulatory response to the crisis was significantly slower to that of the United States. The onset of the decline in profits within the United States was immediately reflected by a similar decline in profits by E.U banks (Clark, Feldman, & Gertler, 2000). The German government and regulators in the finance industry requested the European Commission to bail them out within six months after the crisis began. The bail out of 9 billion Euros was granted and was directed at the IKB German Bank (Grote, & Marauhn, 2006). Furthermore, the governments of other member countries of the European Union pumped in capital within their financial institutions. Examples included the Northern Rock bank located in the United Kingdom. The fast pace of the spread of the financial crisis was not unexpected since most of the securitized United States debt was originated for distribution to European investors and institutions. To this end, the financial crisis that affected the European Union is blamed on the business model of “originate-to-distribute” that is synonymous with U.S banks (Mattoo & Sauvé, 2003). Evidently, the large international financial institution adopted this model which allowed the institutions to increase their lending power without disrupting the set capital standards by regulators. Moreover, this model created instruments such as credit default swaps, mortgages guaranteed by securities, and debt obligation that were collaterized (Ferran, 2012). In this regard, such instruments played a part in exploiting weaknesses evident in financial regulatory structures. In addition, under-written mortgages and securities, insufficient coordination within national regulatory bodies, and regulatory arbitrage by the regulators all played a role in undermining the regulatory structures (Smith, 2005). To this end, the challenge of identifying and enforcing effective measures in response to the financial crisis in the European Union has been slowed down since the financial regulations are normally carried out at the member country and European level ( Helleiner, Pagliari, & Zimmermann, 2010). In light of the financial crisis of 2007-2009, the subsequent sections will address the financial regulatory responses carried out by the European Union as well as changes to the EU regulatory process for financial services. Financial Regulatory Reform Plan by the European Union Following the financial crisis of 2007-2009, the European Parliament Committee for Economic and Monetary Affairs met on 21st July 2010. In this regard, they approved a version of The Dodd-Frank Act adopted by the United States. The new version would seek to improve the regulatory bodies for securities, pensions, insurance, and banking sectors. The Act would also have the authority to overrule national governments on pertinent issues. In addition, the plans by the parliament agitated for the creation of two new funds whereby the large international financial institutions would contribute. To this end, one of the funds would perform the function of depositing insurance funds while the other one would act as a fund for guaranteeing stability. In addition, the contributions to be made by each financial institution were to be pre- determined by the level of asset risk held by the institutions. To this end, the higher the level of risk held by an institution, the higher the financial contribution by the responsible institution to the funds. Furthermore, the reform plan offered provision for the establishment of a European Systemic Risk Board (ESRB) (Kolb, 2010). Evidently, the ESRB would be tasked with identifying and analyzing any dangers posed by macroeconomic that would be detrimental to the European Union economies. The most important part of the reform plan detailed the creation of a modern European System of Financial Supervisors (ESFS). Evidently, it would be composed of new financial regulatory bodies. These were the European Insurance Authority and Occupational Pension Authority (EIOPA), European Securities Authority (ESA), and the European Banking Authority (EBA) (Engelen, 2011). There was equally the creation of new coordinating committee in charge oversight to the pertinent regulators. Evidently, the European System of Financial Supervisors would be composed of a network of national supervisors. In this regard, they would be charged with promoting a sole structure of harmonized rules, as well as enhancing the creation of synchronized supervisory measures to all the financial authorities. Furthermore, it would arbitrate in conflict and dispute resolution among the supervisors. On 11th may 2010, the European parliament sought the approval of a significantly improved strategy of the European Banking Authority. To this end, the amendments that were approved guaranteed overriding power to the ESA, EBA and EIOPA. In this regard, the power superseded that of national regulatory bodies of the member European Union countries. Regulation of Hedge Funds and Private Equity The member countries of the European Union and the European Parliament unanimously approved different strategies of a reform strategy that sought to comply the private equity and hedge funds sector to acquire government authorization. Evidently, the government authorization would regulate the sectors ability to operate, conduct disclosures to investors and regulators as well as possess sufficient capital (Djelic & Quack,2010). However, the existed a differing clause between the two plans. This clause was in connection to the ‘third country’ treatment and the clauses on exemption. To this end, the clause on third country approved by the EU member states made it compulsory for private equity and hedge fund sectors to acquire consent of operation from each member countries of the European Union (Wymeersch, 2012). In relation to the exemption clause, the European parliament exemptions from the regulations would only be possible in the event that the private equity and hedge fund groups had an employee base below fifty people. On the other hand, the proposal by member countries granted exemption to the regulations if the private equity and hedge fund groups had more than 250 employees. Stress Tests In 2010,the European Commission increased its stress tests conducted on European banks to incorporate 70-120 banks (Grundmann, 2011). This was drastic increase of stress tests that conducted on 22 banks in 2009 by the Committee for European Banking Supervisors. The street tests act as quantitative survey that assess the capital competency of financial institutions when subjected to different situations such as outlined decreases in various macroeconomic variables. Evidently, the 22 banks that were street tested accounted for 60% of the assets owned by EU’s banking sector. On the other hand, the expanded street test of 70-120 banks accounted for over 70% of the banking section in the European Union (Craig, & Búrca,1999). The European Commission has also revealed more comprehensive street tests that incorporate the decline in the European Union bond markets that result to increased EU interest rate. To this end, other macroeconomic variables that have been integrated include unemployment, consumer price indexes as reflected by individual EU countries and decrease in economic growth as indicated by the gross domestic product by the European Union. Corporate Governance The European Commission has adopted a number of regulations aimed at improving shareholder rights. This has been through the enforcement of stringent corporate governance regulations on the corporations that conduct operation within EU member countries (Eubanks, 2010). Further measures include that a person is not allowed membership to three different corporate boards as well as restriction pertaining to compensation of the board members. In addition, there would be mandatory expertise in relation to some areas of the corporations operations (Vallance, 2009). Further reforms entailed the regulation of the risk management function by the boards as well as separation of duties of the chief executive officer and the chairman. Credit Rating Agencies The European Commission enforced a reform plan pertaining to Credit Rating Agencies which required them to be registered by a central supervision office. In addition, the Credit Rating Agencies would be expected to adhere to new rules which enhanced transparency within companies that applied for ratings. Furthermore, the reforms would require that the CRA make public their rating methodology. Moreover, the reforms delegated supervision of the CRA’s to the European Securities Market Authority (ESMA) (Cottier, 2012). The ESMA was equally charged with ensuring central oversight of the CRA within the European Union by shifting the role for member countries. Bank Tax for Resolution Fund The European Commission enforced a policy detailing imposition of taxes on banks within the member countries. To this end, the taxes imposed on the banks have been used in setting up a resolution fund (Jackson, 2010). Evidently, the resolution fund is used in the funding of insolvent financial institutions. In this regard, there are few negative impacts on the financial system by exempting bail outs financed by the taxpayers. Consequently, the European Commission has proposed and implemented a range of national funds which have been created in all the 27 EU member countries (Posta, & Talani, 2011). Moreover, there are plans to expand the national funds in the future to an inclusive pan-European fund. The purpose of the plan entails the assessment the tax on all the investment firms as well as deposit operating banks. Conclusion The financial crisis of 2007-2009 which began in the United States produced astronomical financial consequences across the countries of the European Union. However, out of the crisis, the European Union learnt valuable lessons pertaining to inadequacies of replicating a similar business model; as well as drastic reforms needed for improving its regulatory and financial processes. To this end, the European Union has successfully implemented reforms in relation to regulation of hedge and private equity funds, stress tests, corporate governance, bank tax for resolution fund, and credit rating agencies. References Chrisdoulaki, S. (2010). EU's Position Regulations on the financial sector. München: GRIN Verlag GmbH. Clark, G. L., Feldman, M. P., & Gertler, M. S. (2000). The Oxford handbook of economic geography. Oxford, England: Oxford University Press. Cottier, T. (2012). International law in financial regulation and monetary affairs. Oxford: Oxford University Press. Craig, P. P., & Búrca, G. (1999). The evolution of EU law. Oxford: Oxford University Press. Djelic, M., & Quack, S. 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London: The Stationery office. Wymeersch, E. (2012). Financial regulation and supervision: a post-crisis analysis. Oxford, U.K.: Oxford University Press. Read More