Beware of Watchdog?

Morgan O'Rourke


November 1, 2009

In the wake of the global economic crisis, the European Union has proposed sweeping changes to financial sector regulation throughout its 27 member countries. "Our aim is to protect European taxpayers from a repeat of the dark days of autumn 2008, when governments had to pour billions of euros into banks," said European Commission President Jos? Manuel Barroso. "This European system can also inspire a global one."

In a plan revealed in September, the European Commission will create two new watchdog agencies to address both macro- and micro-level concerns. The first, the European Systemic Risk Board (ESRB), will focus on the financial system as a whole and provide an early-warning system for potential risks, such as the existence of unstable asset bubbles or poorly capitalized banks, and offer recommendations to affected countries to mitigate these risks. The second agency, the European System of Financial Supervisors (ESFS), will have similar objectives but will look at individual financial institutions and oversee a network of supervisors in charge of three areas: banking, insurance and occupational pensions, and securities and markets. The supervisors will also create technical standards for each area with the goal of establishing a common EU "rulebook." They will also settle any disputes that may arise.

"The creation of a European Systemic Risk Board to detect and prevent risks to financial stability in the EU and new arrangements to improve supervision at institution level will go a long way towards tackling the imbalances in our financial systems and solving the weaknesses in our financial supervision system that are at least partly to blame for the financial crisis," said Economic and Monetary Affairs Commissioner Joaqu?n Almunia.

The plan has not come without objections, particularly in the United Kingdom, where critics fear that a centrally run ESRB based in Frankfurt, Germany will undermine the authority of the City of London, England's traditional financial center. "We believe the Financial Services Authority and the Bank of England should now start preparing the ground for the new authorities to ensure the UK financial services sector is properly represented on these new European bodies," said Angela Knight, chief executive of the British Bankers' Association. As a result, observers speculate that Mervyn King, governor of the Bank of England, will be tapped for a prominent role in the board in an effort to represent British interests.

Insurance groups have also expressed their concerns. "We will be looking carefully at the Commission's proposals on the supervisory framework to ensure that there are robust checks and balances on the powers to be devolved to regulators," said Stephen Haddrill, director general of the Association of British Insurers. "We are also concerned that the macro-prudential body, the European Systemic Risk Board, is dominated by bankers and does not have enough insurance expertise."

It remains to be seen how these concerns will be resolved, but the Commission hopes that the plan can be approved quickly so that implementation can begin in 2010.

Morgan O’Rourke is editor in chief of Risk Management and director of publications for the Risk & Insurance Management Society, Inc. (RIMS)