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"I cannot stress enough that engaging with the European regulatory process is central to delivering financial regulation in the UK. It needs to be recognised that currently, in respect of prudential regulation, and increasingly over the longer-term in respect of conduct, the rules will be made by Europe and the role of PRA and FCA will primarily be one of supervision and enforcement. Essentially, the UK is moving to become a ‘supervisory arm’ of Europe.
This structural shift for the responsibility for rule-making has profound consequences. The changes we are making to our supervisory model in the UK to move to a judgement-based approach will not in itself be sufficient to improve the soundness of the system materially. Good supervisory judgements have to be exercised within the framework of effective rules.
As the various FSA reports into the crisis have demonstrated, the principal regulatory deficiency, pre-crisis, was the inadequate capital and liquidity standards. Truly effective reform of the regulatory system will thus only be achieved if Europe delivers on the implementation of the Basel III framework.
Let me now turn, in more detail, to how the ESAs will operate and how this will impact the FSA. The financial crisis demonstrated that an effective single European market place requires coordinated regulation delivered to a consistent standard across Europe. The FSA therefore supports the concept behind the ESAs and the necessity of them being strong and independent organisations. The foundation for that strength and independence lies in their members, the national supervisory authorities. The role of the ESAs is to deepen the single market, raise supervisory standards and help mitigate crises through the following key tools:
The ESAs will bring profound changes for both the policy function and firm supervision.
To take policy first. The last 10 years has seen a steady shift of the FSA’s rule-making authority to the European bodies. Since the crisis, this trend has increased as the Commission has changed Directives into regulations and then further increased the level of detail through the new ESA drafted Level 2 provisions - called binding technical standards - which will also be adopted as regulations.
Can I remind you that regulations are fundamentally different from Directives. There is no national intermediation; they apply directly across the EU. This means that in the future the current Handbook will gradually disappear and will be replaced by that of the Commission's. At least we will no longer debate how long a handbook we would like! That will not be our choice.
In future, the FSA’s policy function will focus on two core activities: pure policy analysis and influencing.
In terms of the impact on supervision, there are two very important points I would like to make here. Firstly, there is a pressure to harmonise the way that supervision is carried out. Secondly the by-product of seeking to have common standards, which underpins the concept of a single financial market, runs the risks of removing supervisory discretion in terms of the measures supervisors can take to address firm-specific risk.
On the question of harmonising the way supervisors conduct supervision, there is obviously momentum to have a common supervisory procedural manual. I support the importance of the ESAs having a role in maintaining standards and in doing so they need to be able to participate in peer reviews and have a full understanding of the way a supervisor assesses risk. However, I continue to believe that supervision needs to be delivered locally and be tailored to a particular set of circumstances. Good supervision needs to be based on forward-looking judgements and a deep understanding of firm-specific circumstances. We need to be careful that the philosophy of harmonisation does not undermine this principle. May I make clear, however, my strong support for colleges and data-sharing. In particular, cooperation is crucial to establishing effective recovery and resolution regimes.
On the question of allowing supervisors flexibility to address firm-specific risks, it is vital that the supervisor retains the flexibility to customise the capital and liquidity framework for the individual risk profile of the firm. If Europe harmonised to the point of removing judgement, this will increase not decrease risk. It is crucially important that CRD IV and any future regulations are flexible enough to address these concerns. Furthermore, as the Bank of England and the Financial Policy Committee (FPC) have highlighted, we also need flexibility to apply macro-prudential buffers at the national level or else we will be significantly undermining the ability of the FPC to carry out its mandate.
In conclusion on Europe, the crisis has provided the opportunity to raise standards across the European marketplace but if in doing so we remove the ability of supervisors to make judgements, then we will have created a new set of risks.