In September last year, the European Commission published important proposals to enhance the role of the EU’s three central supervisory authorities: EBA (which regulates banks), EIOPA (regulating insurers) and ESMA (which is the supervisor with responsibility for, among other things, private funds). We reported on these proposals at the time, and they have certainly proved to be as controversial as we predicted then.
On the face of it, the logic for a central regulatory authority (sitting alongside national regulators) to oversee the implementation and enforcement of harmonised rules across the EU seems compelling. And, for politicians worried that clever structures devised by cunning lawyers will enable British-based firms to “have their cake and eat it” – which is the way that some in Europe see the UK’s negotiating position on the terms of its future relationship with the EU27 – beefing up the centralised regulators so that they can oversee the way these structures operate may seem desirable. The alternative, which is to allow national regulators to interpret and enforce EU rules in a way that best serves their national interests, could encourage regulatory competition and trigger a “race to the bottom”.
Of course, the private equity industry is particularly interested in the Commission’s proposals, because the enhanced role for ESMA – in directly supervising certain EU regulated funds, and in having close oversight of any authorisation that includes proposals to delegate significant functions outside the EU – would have a significant impact on many firms, and would probably be the start of a process leading ultimately to a significantly reduced role for national regulators. But the concerns go far wider, and many have argued that the Commission’s proposals are poorly thought through, unnecessary (because ESMA already has this central co-ordination role), and need considerably more thought. Some even suggest that they should be torn up. There are other ways to address the legitimate concerns of policy-makers – and of market participants, who are the ones to suffer from fragmented regulation.
There are a number of reasons to be sceptical about the proposals that have so far been published, as we discussed with a range of interested parties at our Funds Forum in Frankfurt last week. One question is whether the proposed governance structure, not all of which is spelled out in the draft Regulation, is appropriate. The main governing body, which would comprise a chair and at least three independent members, would oversee the work of ESMA, and would do so in the interests of the EU as a whole. The Commission argues that this reduces the risk of conflict of interests, but making the central decision-maker more remote from regulated entities – many of which are small, domestic players – seems unlikely to improve the quality of regulation as it is experienced by firms on the ground.
If the role of ESMA were to remain roughly as it is now, that might not be a problem. But that is not the intention: several new powers are foreseen, and would surely be followed by others. Venture capital firms (and even larger managers that also run venture funds alongside other strategies) might be the first to feel the impact because those opting in to the EU’s venture capital regulation, EuVECA, would become directly regulated by ESMA in Paris instead of by their national competent authority (at least in relation to that aspect of their business). What benefit there would be to them is not clear but, since the costs of the regulator would be borne by regulated firms, it is certain to be more expensive. And, in a move unlikely to be welcomed by US managers in particular, the proposal that ESMA must review delegation arrangements on a case-by-case basis would add time and administrative burden to the authorisation process.
These proposals will not have a smooth ride through the legislative process, and national governments are likely to be among those who object to them. More work is needed: first to identify demonstrable real-life problems, and then to craft appropriate solutions. All stakeholders need to engage constructively to achieve that. Regulated firms are well aware that fragmented rules are a problem that needs fixing, and not every country is fortunate enough to have a regulator with experience of private equity and venture capital, which exacerbates the problems. On the other hand, it is not at all clear that these proposals are the right way to fix them.