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The European Securities and Markets Authority (ESMA) officially became a European financial services regulator on 1 January 2011. One year on, this article summarises some of the key areas in which ESMA has been active and explains ESMA's role and its relationship with other EU regulatory bodies, as well as national regulators.
Background – Regulatory Reform
Following the recent global financial crisis, the European Commission published legislation establishing a European System of Financial Supervision (ESFS). This system comprises three new European Supervisory Authorities (ESAs) and the European Systemic Risk Board (ESRB). While the ESRB has a high-level supervisory role and is tasked with monitoring the financial system as a whole, each ESA has a specific responsibility for banking, insurance, or securities. ESMA is the ESA with responsibility for the securities industry. ESMA was founded by the ESMA Regulation1 (Regulation) and takes over the tasks previously performed by the Committee of European Securities Regulators (CESR). In addition, ESMA has additional supervisory powers under the Regulation. Moreover, ESMA is tasked with safeguarding the stability of the EU's financial system and attempts to ensure the integrity, transparency, and orderly functioning of its securities markets. ESMA also has the protection of financial investors as an overarching goal. It is clear that the scope of work undertaken by ESMA is broad. As part of its role in standard-setting and reducing the scope of regulatory arbitrage, ESMA seeks to strengthen international supervisory co-operation. In addition, it also contributes to the work of the ESRB, which identifies risks to the financial system and provides regulatory advice to reduce threats to the EU's financial stability. ESMA is fully independent, but there are accountability channels to the European Parliament as well as to the European Council and the Commission. There is an obligation to report regularly at meetings with the Commission and also to provide a public Annual Report. In practical terms, ESMA is expected to contribute to the legislative process at the European level. Occasionally, it will provide technical advice to the Commission at the initial drafting stage of European legislation. In contrast, ESMA has a far more significant role at the "secondary level" and takes responsibility for drafting subordinate legislation (such as delegated acts and implementing acts) and provides advice on the application and interpretation of European law. This subordinate legislation is concerned with the substantive content of the legislative requirements. In short, much of the detail and practical processes are set out at this stage of the process, and ESMA has the key role of advising on these issues. A recent example is ESMA's technical advice2 on the Alternative Investment Fund Managers Directive (AIFM Directive).3 Responsibility also falls on ESMA as necessary for producing guidelines and recommendations for ensuring effective and efficient supervisory practices within the newly created ESFS. Ultimately, the creation of a single EU-wide rule book and the consistent and uniform application of financial regulation are at the heart of its objectives.
— Powers & Competencies
The legislation establishing the ESAs has empowered them to create a single EU rulebook, which will apply in all Member States. By formulating technical standards, the ESAs will, together, create a much more harmonised rule book for the EU. Through the use of guidelines, recommendations and opinions, ESMA will be able to contribute to the harmonised implementation of financial supervision. In addition to the work previously performed by CESR, ESMA has been awarded additional tasks and powers, including the:
— ESMA's Governance Structure
ESMA is governed by two bodies. The first is the Board of Supervisors, which brings together the heads of national competent authorities (such as the head of the UK Financial Services Authority). The second is the Management Board, which is comprised of six members of the Board of Supervisors (amongst others). The Management Board is tasked with management roles such as the development of an annual work programme, setting annual budgets, and staffing. Thanks to the introduction of ESMA and new governance structures, decision-making processes no longer rely on consensus, as all key decisions can now be taken by majority vote. When deciding matters of policy, the voting process is Qualified Majority Voting, while, in other areas, the Majority Vote system is used. The Executive Director of ESMA, Verena Ross, believes that this makes a significant difference for those wanting to influence decisions. One Member State can no longer hold up decisions with arguments based on purely nationalistic reasons. Influential arguments need to be European in approach to carry favour with the majority of ESMA.4
— ESMA's Consultation with Stakeholders
During 2011 ESMA continued its practice of public consultation. ESMA's Securities and Markets Stakeholder Group (SMSG) provides advice on technical standards and their implementation. One of the group's key roles is to advise ESMA on the impact of proposed draft regulatory standards and to discuss and assess their impact on individual financial institutions. The SMSG is comprised of a range of stakeholders including financial services intermediaries, market infrastructure providers such as regulated markets, multilateral trading facilities (MTFs), and trade repositories.
Key Areas of Activity
— Single Rule Book
The creation of a single rule book began in earnest during 2011, given the significant amount of new legislation during the year. Reform of CRA regulation (see below), drafting technical advice on the European Markets Infrastructure Regulation (EMIR),5 the short selling regulation,6 the AIFM Directive, the Prospectus Directive,7 and other areas have all occupied ESMA this year.
— Secondary Markets
During its inaugural year, ESMA has carried out extensive work in areas related to secondary financial markets. These issues include the structure of markets as well as the transparency and efficiency of secondary markets. Some high profile activities relate to types of trading platforms and over-the-counter (OTC) trading. The ESMA Secondary Markets Committee is particularly busy. It has taken responsibility for work relating to MTFs and systemic internalisers as well as advising on aspects of the reforms to MiFID8 (by the proposed MiFID II Directive9 and Regulation10), such as MiFID's application to trading platforms, together with pre- and post- trade transparency. In the area of investment funds, on 16 November, ESMA published its Level 2 technical advice on the implementation of the AIFM Directive.11 The advice adds detail to the high level framework of the AIFM Directive. The Level 2 guidance discusses detailed issues relating to the liability of depositaries, transparency, and delegation. In a separate area, ESMA has published a consultation paper outlining proposals for EU guidance aimed at trading platforms,12 financial investment firms, and regulators to address emerging concerns about the use of high frequency trading in highly automated trading environments. An area in which ESMA's review of secondary markets hit the headlines was the banning of net short positions in mid-August 2011 by France, Belgium, Italy, and Spain. The co-ordination of the content and timing of the ban was carried out centrally by ESMA.
— ESMA's Work to Improve Transparency
Improving transparency has been another area in which ESMA has been active. Since the EU sovereign debt crisis began earlier in the year, the Authority has stepped up significantly the monitoring of financial markets and has exchanged information with national regulatory authorities on issues such as the resilience of trading venues and trading platforms, settlement failures, and exposures to credit default swaps (CDS). A further example of the work undertaken by ESMA to improve transparency in the area of investment management is the publication of a consultation paper on the policies relating to undertakings for collective investments in transferrable securities (UCITS). Following a review, ESMA concluded that the existing regulatory regime was insufficient when considering the specific risks associated with these types of funds. According to ESMA, increasing the level of transparency available to investors is a key aspect of investor protection and the transparency of exchange traded funds and structured UCITS needs attention.13 In the arena of alternative investment funds, the level of information that will need to be provided by fund managers to regulators will increase under the AIFM Directive. To improve transparency between regulators and CRAs, ESMA has published a set of regulatory standards that contain rules on the specific content of the information to be provided by CRAs to ESMA.14
— Credit Rating Agencies
ESMA is now exclusively responsible for the registration and the supervision of CRAs in the EU. As well as performing a supervisory function, ESMA performs a policy initiative function by preparing technical standards and advisory guidelines. This work is carried out by the CRA Technical Committee, which is comprised of representatives of all of the national competent authorities. The CRA Technical Committee is responsible for a number of tasks including the implementation of Regulation 1060/2009 as amended by Regulation 513/2011 (CRA Regulation) and co-ordinating with Member State regulators and the other ESAs.
— European Markets Infrastructure Regulation – OTC Derivatives
EMIR reforms the way in which OTC derivatives are traded. Under EMIR, central counterparties will centralise the clearing of all standardised OTC derivatives traded by financial and certain non-financial firms. This system of clearing OTC derivatives is intended to improve the safety of the market by reducing counterparty risk. Greater transparency will be introduced via reporting obligations to trade repositories. ESMA is now compiling binding technical standards to finalise the details of the regime. Work is taking place with the Commission and the U.S. authorities to ensure issues surrounding extra-territoriality are resolved.15
It is clear that ESMA has made great progress against its objectives during 2011. The ongoing reform of financial regulation and the raft of new EU legislation in the financial services sector require technical standards of the highest quality. ESMA needs to be given the time and resources to consult stakeholders to succeed in this regard, in order to ensure a successful and viable EU financial services industry. While 2011 was a busy year, ESMA expects 2012 to be equally busy, if not more so, and is likely to have to draft approximately 40 separate technical standards. MiFID II will be particularly burdensome.16 EMIR is now being finalised, and ESMA expects to draft approximately 30 binding technical standards on EMIR alone during the legislative process. As if that was not enough, the Commission has asked it to produce technical standards on short selling and CDS by March 2012. Adrian Brown is a partner and head of the financial services regulatory practice at Nabarro LLP. He advises investment banks, broker dealers, fund managers and corporate finance houses on all aspects of financial services regulation. Telephone: +44 (0) 20 7524 6400; E-mail: email@example.com.Sam Robinson is a senior associate in the financial services regulatory practice at Nabarro LLP. Sam has advised a number of clients including banks, stockbrokers, fund managers and investment advisers on all aspects of financial services regulation. Prior to working in private practice Sam worked for seven years at the FSA, the majority of that time in the FSA's General Counsel's Division. Telephone: +44 (0) 20 7524 6836; E-mail: firstname.lastname@example.org.
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