Bruegel: EBA relocation should support a long-term ‘twin peaks’ vision

06 April 2017

As the Commission launches a review of European financial supervision, authors argue that Europe needs to move towards a twin peaks model – dividing supervision of prudential and conduct-of-business issues. But this is a long-term vision, and will require institution building.

The immediate priorities are to choose a new home for the EBA and reinforce ESMA.

The European Commission recently published a consultation on the operation of the European Supervisory Authorities (ESAs), the three EU financial regulatory agencies established in 2011. This debate is timely. In the short term, Brexit will force a relocation of the European Banking Authority (EBA), which is currently based in London. Separately, but also as a consequence of Brexit, the European Union needs to rethink its capital markets oversight framework. Following the recent pooling of euro-area banking supervision at the European Central Bank (ECB), it should further separate prudential oversight from the protection of savers, investors and market integrity, thus implementing an institutional concept known in financial regulatory debates as “twin peaks.”

The three ESAs are the EBA, the European Insurance and Occupational Pensions Authority (EIOPA), and the European Securities and Markets Authority (ESMA). This sectoral approach of having separate bodies for banking, insurance and securities is a historical legacy.

In fact, the apparent institutional parallelism between the three agencies was slightly misleading from the start. Not only do they cover different sectors, they also have different roles. Notably, ESMA was quickly granted directly binding powers over several market segments: it is the sole supervisor of credit market agencies and trade repositories, and it also has authority to recognise third-country Central Counterparties (CCPs) for their operation in the European Union. In 2015, ESMA created a dedicated Supervision Department to handle these tasks. The EBA and EIOPA have no comparable competencies.

Almost a decade later, after major developments like banking union and Brexit, it is time to re-examine the ESA architecture. It should be reframed in a long-term vision for EU financial oversight, and this vision should bebased on the ‘twin peaks’ concept. Twin peaks is shorthand for the separation of conduct-of-business supervision from prudential supervision, originally proposed by Michael Taylor in a 1995 pamphlet and since adopted by jurisdictions including Australia, the Netherlands and the UK.

There are three main reasons to support a twin peaks model:

• First, Europe’s banks and insurers are often linked in financial conglomerates, which warrants integrated supervision of banking and insurance. Since the European Union does not appear to envisage a tighter regulatory separation between banking and insurance, it should move towards more integrated prudential supervision of both sectors. In the same spirit, the European Union should amend its capital requirements legislation to reverse the so-called Copenhagen compromise, which allows for double-counting of the same capital for banking and insurance regulation purposes and does not fully comply with the global standards set by the Basel Committee on Banking Supervision.
• Second, the EU27 urgently needs to upgrade the supervision of its capital markets after Brexit. An empowered EU-level markets supervisor – in practice, a reformed ESMA with additional direct authority – is needed to adapt quickly to this new reality. This would help to revive the EU’s capital markets union, whose rationale is sound but which so far has delivered only limited results. A twin peaks design enhances the importance of the markets supervisor by granting it authority over most aspects of the protection of investors’ and savers’ interests.
• Third, prudential supervision and conduct-of-business supervision (including markets supervision) require different mindsets, skills and approaches. Prudential supervision requires staff trained in economics, finance and/or accountancy, while conduct-of-business supervision is more behavioural and legalistic. Conduct-of-business supervision involves policing the conduct of financial institutions in the markets (insider trading, market abuse, disclosure, etc) and towards clients (adequate information provision, duty of care, know your customer, etc). But on these issues, long and sometimes painful experience demonstrates that prudential supervisors often prioritise the interests of supervised entities over those of their customers.

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