Editorial – Financial regulation: a modern Great Game

In November 2008, an unprecedented round of international financial cooperation started at the G20 Washington Summit. At the beginning of what became the “Great Recession”, the goal was to join all political, economic, financial and monetary forces to save a financial system on the verge of collapse. Brexit and the election of Donald Trump as President of the United States have jeopardized this existing consensus. Less than a decade later, as memories of the financial crisis fade, regulatory issues are now at the center of a political battle, in which the European institutions play a decisive role.

A regulatory competition?

In February, at Bloomberg’s premises in London, Valdis Dombrovskis, Vice President of the European Commission in charge of financial services, usually cautious when it comes to international politics, gave a warning to the EU’s main partners on their approach to international regulatory cooperation. Stressing that the financial system was “inherently international” and that financial stability could not be achieved without a strong cooperation between the different jurisdictions, he explained that the Commission would not hesitate to “reassess” equivalence regimes and access to the single market, should the international rules and standards be questioned or not respected.

Targeting Donald Trump, he deemed “difficult not to notice […] when an American President talks about ‘doing a big number’ on Dodd Frank”, the cornerstone of the banking regulation adopted in the United States in 2010. In this respect, the European institutions considered especially paradoxical the tough bargaining position of the U.S. Treasury in the negotiations aimed at finalizing Basel III. The new American administration defended a high output floor for internal rating models on which a lot of European banks rely, unlike their US counterparts. This situation led Olivier Guersent, General Director of the Commission’s department responsible for EU policy on banking and finance, to call on the United States to no longer use international negotiating forums as an « offensive regulatory weapon in the competitive game« . This statement, together with the postponement of the Basel III negotiations, have showed the Europeans’ willingness to defend the interests of their financial industry.

The early stages of the Brexit negotiations reflected the same determination. Even if the “Great Repeal Bill”, which aims at copying all existing EU legislation into domestic UK law to ensure a smooth post-Brexit transition, EU leaders are worried about potential future regulatory divergence with the United Kingdom. These concerns were fueled by the UK leaders themselves and Philip Hammond, Chancellor of the Exchequer, who threatened to abandon European-style taxation and regulation systems to support British financial services’ competitiveness. In order to avoid any “regulatory dumping”, the Member States of the European Union defined, in the Brexit negotiation mandate given to the EU Commission, some of the core positions and principles that the Union will defend throughout the negotiation. Consequently, they have clearly required from the EU executive body to “ensure a level playing field, notably in terms of competition […] and in this regard encompass safeguards against unfair competitive advantages through, inter alia, tax, social, environmental and regulatory measures and practices.”

The EU institutions go on the offensive

If Brexit and the changes brought by the Trump administration put the Europeans on the defensive, the EU institutions and the European Central Bank (ECB) seem to be committed to using these political upheavals as an opportunity vis-à-vis non-European countries and Member States. The Commission’s Brexit mandate contains only one sentence related to financial services, summarizing EU institutions’ overall approach: “any future framework should safeguard financial stability in the Union and respect its regulatory and supervisory regime and standards and their application”. Any substantial discussion regarding access to the Single Market will be conducted with the aim to mitigate EU risk-exposure to the UK. Therefore, should a transitional period for financial services be agreed on, the EU will at least require UK-based financial institutions to meet EU regulation requirements, with a sound supervision.

The Commission’s proposal published in June for a regulation to strengthen the monitoring of central counterparties (CCPs) in the EU and in third countries goes a step further. According to the text, CCPs of systemic importance in clearing financial instruments denominated in a European currency will have to implement a prudential regime set by the EU, under the supervision of the European supervisory authorities and of the central banks of the EU. The largest CCPs, which are currently all settled in the UK, could even be forced to relocate their activities in the European Union. In fact, by constraining some CCPs established on the United Kingdom territory to comply with EU law or to relocate to the Union, the EU would create an extraterritoriality effect for its rules, applying to activities dealing in one of its currencies – as the United States have already developed with the dollar.

The European Commission’s initiative to require an intermediate parent undertaking (IPU) for third-country banks operating in the EU is also quite revealing of the means to come out of Brexit on top. The proposed measure would require credit institutions based in third-countries and whose assets are above €30 billion in at least two Member States of the European Union (EU) to set up within the EU an IPU under European supervision. Taken individually, many of the branches and subsidiaries of these third-country credit institutions are not considered as systemic. As a consequence, they are currently under a national supervision, which can be more or less permissive depending on the country concerned. If the aim is to avoid a « regulatory race to the bottom » between Member States to attract financial institutions in the context of Brexit, one of the outcomes will be to remove some of the powers of the competent national authorities, whether for the granting of banking licenses or as a supervisory authority.

Political developments in the Anglo-Saxon world seem to have led Americans and Britons, yesterday heralds of liberalism and international cooperation, to abrupt paradigm shifts. However, monetary or regulatory tools have always been used in a context of international competition. « The dollar is our currency but it’s your problem » declared in front of his European counterparts John Bowden Connally, Secretary of the U.S. Treasury, in 1971. The only difference is that today the European institutions do not wish to bow down. And that they have the means to do so.