Comments on topics related to “financial supervision”.

This paper addresses two separate questions that are immediately relevant to the discussions surrounding the reform of the Regulatory framework of the Financial system.

-          Responsibility of Supervisors

-          Tax havens.

Responsibility of Supervisors:

The recently published comparative study prepared by CEBS concerning le powers of the Bank Supervisors in the 27 Member states is comprehensive and provides a good basis for evaluating the degree of convergence already attained as well as the important steps that need to be implemented to achieve a level playing field (avoiding regulatory arbitrage) as well as more uniform standards, particularly in the field of “enforcement”.

This valuable work would have been even more useful if a section had been devoted to the accountability of Supervisors in their respective jurisdictions. The Commission should ask CEBS to provide this additional information.

The de Larosière report touches lightly on the subject of the accountability within the new proposed institutional structures:  the ESRC (art. 182) and the EFSF (art. 187).

In the case of the ESRC, the Report makes a specific proposal (last § of Recommendation 17) but it does not amount to much more than an exercise in “passing the buck” to another Committee (EFC/ECOFIN) whose powers would need to be amended in order to provide it with the necessary authority to act. Given its current structure, one must have real doubts as to whether either the EFC or ECOFIN would ever be entrusted with the power to “sanction” a national supervisor, have the political will to do so and even whether these bodies are the most appropriate to carry out such duties. The alternative of giving the ESRC itself limited direct sanctioning powers would be more efficient. As suggested by the Report, it would remain accountable, also in this respect, to the oversight of EFC/ECOFIN but also report to the European Parliament.

Regarding the EFSF there is a lack of clarity concerning the articulation of its responsibilities and those of the three “Authorities” it federates which can only lead to a “dilution” of accountability. For instance, no indications are given concerning the “pluridiciplinarity” of Colleges for cross border institutions active in areas “crossing” the lines of supervisory responsibility between Authorities.  Are these Colleges accountable to the (decentralised) EFSF itself as a body or to one or all of the Authorities? In parallel to the “limited” sanctioning powers suggested here above for the ESRC, similar “limited” powers should be given to the EFSF with regard to the performance of national supervisors within the context of the work performed by the Colleges.

Without a minimum of enforcement powers devolved to both the ESRC and EFSF, there can be little doubt that the Report’s meritorious attempts to fully take into account the principles of “subsidiarity and proportionality” embedded in the Treaty in the name of “political pragmatism” and “consensus preservation”, will lead to an overly complex and sub optimally efficient architecture, the weakness of which is likely to emerge precisely in a crisis which it is supposed to prevent. 

Another aspect, overlooked by the de Larosière Report, which could add significantly to the transparency of supervisory accountability, concerns the requirement for supervisors (at all levels) to deliver “compliance certificates” to the institutions for which they exercise supervisory responsibility. This could take a form similar to the certificates delivered by chartered accountants and be appended to the annual accounts of the financial institutions concerned.  The purpose of such an obligation would be twofold:

-          On the one hand it would serve as a powerful incentive to foster compliance by the supervised entities, since a critical wording of the annual certificate could severely impinge on the reputation of an institution that would be found deficient. This can be seen as encouraging “preventive” actions by the controlled entities.

-          On the other hand it would foster the responsibility of the Supervisors themselves who should be held accountable for the quality of the supervisory work they carry out. It would seem awkward indeed, if the reform of the financial system would focus solely on reinforced supervision and accountability of “rating agencies” without applying similar standards to other bodies that are entrusted with reassuring the public at large on the health of the financial system.

Tax havens

Within the framework of the forthcoming G20 meeting, a lot of welcome attention is being directed at the fight against tax evasion, money laundering and the financing of illegal activities. Most of the measures that are being envisaged concern bringing pressure to bear on jurisdictions that do not fully cooperate and some immediate results are already forthcoming, mainly from countries who wish to avoid the stigma of being tarred with the brush of “aiding and abetting” tax fraud. These measures may however prove to be insufficient to overcome the strong temptation of individuals to escape the tax net, provided that the risks remain “acceptable”. Approaching the problem from a different angle, in addition to the avenues being currently explored, might prove fruitful.

Among the measures to overcome the financial crisis, particular emphasis has been put on reassuring the public at large on the safety of the financial institutions with which they deal. In particular, consideration is being given to the best ways of extending national “deposit insurance schemes” in a coordinated fashion to combine both the safety aspects with a level playing field. It seems therefore possible, while leaving the details of national schemes to local authorities, to consider linking these schemes in a “worldwide network”  who’s Secretariat could be entrusted to the IMF and would oversee the “registration/licensing” of participants.

The scheme would operate on two levels:

-           First, it would link countries participating in the scheme that would adhere to a set of common principles and rules.

-           On a second level it would provide for the “registration/licensing” of individual financial institutions operating within participating jurisdictions.

The scheme would incorporate common features such as:

-          The maximum amount covered per beneficial owner of an account;

-          The obligation of participating institutions to “report” transfers to/from “unregistered/unlicensed” institutions;

-          Communication by account holders of “beneficial ownership” should be compulsory.

-           “Reciprocity”: no discrimination between the treatment of nationals and foreigners of countries subscribing to the scheme.

 as well as rules covering:

-           “Exchange of information”: to benefit from insurance coverage, account holders would release the institution from restrictions in communicating information within agreed procedures.

-          “Burden sharing”: ex ante arrangements for the mutualisation of certain risks between participating national schemes.

-          “Supervision”: Jurisdictions participating in the scheme would agree to sharing information between supervisors as well as to joint inspection procedures if doubts were raised concerning the appropriate level of cooperation.

Participation in the “network” would be made public, for instance through the publication on the Webb site of the Secretariat of the list the countries/institutions partaking in the scheme. Failure to appear on the list would alert both potential customers and banking correspondents that they are carrying out business at their own risk and peril with an “unregistered” counterparty and can expect “no bail out” in case of trouble.

Such a scheme should have a major dissuasive impact increasing significantly the risks assumed by clients tempted to deal with “unregistered” institutions. These arrangements should also make money laundering more difficult, complicate illegal drug and arms traffic as well as the illicit financing of terrorist activities.

Though joining the scheme is “voluntary”, its efficiency could prove extremely powerful if sponsored by the G20 as part of the reform of the overall architecture of the global financial system.

Brussels, 16th March 2009 

Paul N. Goldschmidt

Director, European Commission (ret.)