# EUR-Lex - 52014DC0279 - EN

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# 52014DC0279

**COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE REGIONS A reformed financial sector for Europe /* COM/2014/0279 final */**

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1.         Introduction

In 2008, the
world was hit by a financial crisis which was global in scale and imposed
significant costs on the EU economy and its citizens. In the immediate
aftermath of the crisis, the EU took the lead in a decisive global regulatory response.
Together with its international G20 partners, the EU committed to engage in a
fundamental overhaul of the regulatory and supervisory framework of the
financial sector.

Alongside its
control over state aid granted during the crisis, the Commission acted quickly
to make immediate regulatory interventions that strengthened deposit guarantee
schemes and reformed accounting rules. Following the recommendations of a group
of high-level experts set up by the Commission and chaired by Mr de Larosière,[1] in
2009[2]
and 2010 the Commission set out the way forward for improving the regulation
and supervision of EU financial markets and institutions. It announced a set of
legislative measures to bring about a safe and responsible financial sector
conducive to economic growth.[3]

Given the
interconnections between Member States that share a common currency, it also
became clear that there were specific risks which threatened financial
stability in the euro area and the EU as a whole. This called for deeper
integration to put the banking sector on a more solid footing and restore
confidence in the euro, by creating a Banking Union with single oversight and
resolution of banks in the Member States of the euro area, and potentially open
to all Member States if they wish to take part.[4]

Over the past
five years, more than 40 proposals have been tabled by the Commission (many of
which are already in force) aimed at restoring market confidence, financial
stability, and the integrity and efficiency of the European financial system.

The first positive
effects of the reformed financial system can already be observed and continue
to unfold. Ongoing monitoring and review will be necessary to further evaluate
the implementation and the overall impact and effectiveness of the reforms.

This
Communication takes stock of the progress made in reforming the financial
system and, where already possible, assesses the overall impact of the EU
financial regulation agenda. More detail is provided in the Staff Working
Document 'Economic Review of the Financial Regulation Agenda'.[5]

2.         The
cost of the crisis and the need for regulatory reform

Financial
institutions and markets play a vital role in any developed economy. They
provide lending to households and businesses. They allow individuals to save
and invest for their future and channel savings to support the economy. They help
corporations and households to better manage and insure against risks; and they
facilitate payment transactions. By performing these key functions, a
well-functioning financial system contributes to economic prosperity,
stability, and growth. However, failure of the financial system may have
profound negative consequences for the wider economy as demonstrated by the recent
crisis.

In the years
preceding the crisis, the financial system had grown significantly in size and had
become increasingly interconnected through long and complex global
intermediation chains of claims, increasing systemic risks.  Across the world,
leverage strongly increased, and banks started to rely more on short-term
funding and engaged in increasingly hazardous maturity transformation. The
rapid growth of the financial sector was also facilitated by a surge in
innovative but often highly complex financial products that allowed financial
institutions to expand activities, also off their balance sheets.

Policymakers,
regulators and supervisors around the world failed to identify and adequately
address the risks building up in the financial system. Many activities largely
escaped any regulation and oversight. While the operations of the largest
financial institutions expanded significantly across borders and markets became
increasingly integrated internationally, regulatory and supervisory frameworks
remained largely nationally focused.

With the start
of the financial crisis, these deficiencies unravelled. What started as a
sub-prime crisis in the USA in 2007 quickly spilled over into a full-blown
global financial crisis. In Europe, the financial crisis later turned into a
wider sovereign debt crisis with significant implications for the economy as a
whole.

The economic and
financial crises imposed significant costs on the EU economy. Between 2008 and
2012, a total of €1.5 trillion of state aid was used to prevent the collapse of
the financial system.[6]
The crisis triggered a deep recession. Unemployment rose sharply, and many EU
households experienced significant losses in income, wealth and opportunities.

3.         The
objectives and expected benefits of the reforms

The EU financial
regulation agenda has been guided by the aim of creating a safer, more
transparent, and more responsible financial system, that works for the economy
and society as a whole and contributes to sustainable growth. The reform
measures deliver on these objectives by:

Restoring and deepening the EU
  single market in financial services
 Establishing a Banking Union;
 Building a more resilient and
  stable financial system;
 Enhancing transparency,
  responsibility and consumer protection to secure market integrity and
  restore consumer confidence; and
 Improving the efficiency of the EU
  financial system.

The large number
of regulatory reforms undertaken at EU and global level, and their broad scope,
is a reflection of the diversity and severity of the problems undermining the
functioning of the financial system prior to the crisis. No single reform would
have been capable, on its own, of achieving all the objectives set out above. Furthermore,
it was important not only to address the failings identified by the crisis, but
also to anticipate other potential problems that could affect the financial
system. The different measures have been designed with a view to complementing
and reinforcing each other. While it is too early at this stage to exhaustively
identify and assess the complementarities of the reform agenda, many have
already emerged (e.g. reforms to the institutional framework strengthening the
single market and the functioning of EMU contribute to both financial
integration and financial stability; measures to enhance transparency
contribute to both financial stability and efficiency) and further synergies
are expected to materialise in the future as the measures are implemented.

3.1       Restoring
and deepening the EU single market in financial services

The financial
crisis showed that no Member State alone can regulate the financial sector and
supervise financial stability risks when financial markets are integrated. In
the wake of the crisis, the Commission therefore announced a consistent
response to the crisis across the whole EU. This also allowed for better
coordination with international partners.

Before the
financial reform, EU financial services legislation was largely based on minimum
harmonisation, allowing Member States to exercise considerable flexibility in
transposition. This sometimes led to uncertainty among market participants
operating cross-border, facilitated regulatory arbitrage and undermined
incentives for mutually beneficial cooperation. The Commission therefore proposed
the establishment of a single rulebook, providing a single regulatory
framework for the financial sector and its uniform application across the EU.

An important
step in the deepening of the single market in financial services was the creation
of the European System of Financial Supervisors (ESFS)[7],
including the European Banking Authority (EBA), the European Securities and
Markets Authority (ESMA), and the European Insurance and Occupational Pensions
Authority (EIOPA). These Authorities, operating since 1 January 2011, have guaranteed
consistent supervision and appropriate coordination among national supervisory
authorities in the EU. In addition, the European Systemic Risk Board (ESRB) monitors
macro-prudential risks across the EU and issues warnings and recommendations to
call for corrective action.[8]

The reform
agenda proposed by the Commission was complemented by a cross-sectoral sanctioning
regime to ensure proportionate and timely enforcement through more
effective and deterrent sanctions.

3.2       Establishing
the Banking Union

The crisis
revealed the incomplete nature of integration in the euro area and weaknesses
in the institutional structures supporting economic and monetary union (EMU).
The crisis abruptly reversed banking market integration, and fragmentation
threatened the integrity of the single currency and the single market. While
banks had diversified geographically and engaged in significant cross-border
activities, they remained closely linked to the Member State in which they were
headquartered, contributing to the negative sovereign-bank feedback loop that
weakened banks and sovereigns and resulted in unreasonable financing costs in
some Member States. This called for a deeper integration, at least in the euro
area, for the supervision and resolution of banks. While Banking Union is
mandatory for euro area Member States, it is an inclusive system and open to
participation of all EU Member States.

The first pillar
of the Banking Union is the Single Supervisory Mechanism (SSM)[9], which
transfers key supervisory tasks for banks in the euro area and other participating
Member States to the European Central Bank (ECB). The ECB will fully carry out
its new supervisory mandate as of November 2014. In preparation for its new
supervisory role, the ECB is currently conducting an asset quality review (AQR)
and a stress test, in coordination with the EBA, which will be vital for
restoring confidence in the European banking system and ensuring a smooth
transition towards the SSM. The EBA will remain a central actor in further
developing the single rulebook and a coordinated supervisory approach.

The second
pillar of the Banking Union - the Single Resolution Mechanism (SRM)[10] – will
apply an integrated and effective resolution process at European level for all
banks in Member States subject to the SSM. Resolution will be financed in the
first place by shareholders and creditors and, as a last recourse, by a Single
Resolution Fund, funded through bank contributions.

The Banking Union
is expected to ensure high, common standards for prudential supervision and
resolution of banks in the euro area and participating Member States. It will
also improve financial integration and help ensure the smooth transmission of the
ECB's monetary policy.

3.3       Building
a more resilient and stable financial system

In
recent years, the Commission has presented a series of measures to strengthen
the stability and resilience of the financial system.

In the
banking sector, only weeks after the failure of Lehman Brothers in 2008,
the Commission proposed to increase the coverage level of deposit guarantee
schemes (DGS), which led via an interim step to a harmonised coverage of
€100,000 since 2010.[11]
This measure immediately increased depositor confidence in public safety nets
and thereby successfully mitigated the risk of runs on banks across the EU.

The new Capital
Requirements Regulation and Directive (the 'CRD IV package')[12] is increasing
the level and quality of bank capital and setting minimum liquidity standards,
making banks more resilient. The CRD IV package also requires banks to
build additional capital buffers for future periods of stress and introduces
additional capital requirements for systemically important banks to reduce systemic
risk in the banking sector. Earlier reforms of the CRD had already addressed
key issues such as remuneration policy and risk retention for securitisation.

The Directive
for bank recovery and resolution (BRRD)[13]
will put in place the necessary tools and rules to ensure that the costs of bank
failures are not borne by taxpayers, and that EU banks can be resolved in an
orderly fashion. It will thereby reduce systemic risk and the need for state
aid to maintain financial stability.

The reforms in
the banking sector were complemented by reforms to improve the functioning of financial
markets and increase the stability and resilience of financial market
infrastructures. The revised Markets in Financial Instruments Directive
(MiFID II)[14]
strengthens organisational requirements and safety standards across all EU
trading venues and extends transparency requirements to bond and derivatives
markets.

The European
Market Infrastructure Regulation (EMIR)[15]
and MiFID II improve the transparency of derivatives that are traded
over-the-counter and reduce the counterparty risk associated with derivative
transactions. By imposing common prudential, organisational and business
conduct standards, the Regulation on central securities depositories (CSDR) [16]   increases
the resilience of EU central securities depositories and enhances the safety of
the settlement process.

Together, MiFID
II, EMIR and CSDR set a coherent framework of common rules for systemically
important market infrastructures at European level. A regulation was also
adopted to address specific concerns raised by short-selling and credit default
swaps.[17]

In addition, as
part of the EU effort to ensure financial stability, the reform agenda included
a number of key measures to reduce systemic risk stemming from outside
the regular banking system[18], including
for example the Alternative Investment Fund Managers Directive[19] and
the proposed Regulation on Money Market Funds.[20]
Work in this area continues.

Stability has
also been reinforced by a risk-based regulatory framework for the insurance
sector (Solvency II)[21],
which will improve solvency and risk management standards, thereby increasing
the resilience and stability of the European insurance sector.

Taken together,
these measures will reduce the build-up or emergence of systemic risk across
the financial system, thus reducing the likelihood and severity of future
financial crises.

Only for certain
particularly interconnected and systemically important banks, does the
comprehensive set of measures proposed appear insufficient to ensure that those
banks can be resolved without negative impacts on financial stability or
intervention by taxpayers. Following the recommendations of the high-level
expert group, chaired by Mr Liikanen,[22]
in early 2014 the Commission proposed a set of structural measures for those
banks, including a prohibition for a bank to trade on its own account and a
separation of trading from deposit-taking and other retail banking activities
where necessary to ensure resolvability.[23]

3.4       Enhancing
transparency, responsibility and consumer protection to secure market integrity
and restore consumer confidence

Market integrity
requires trust and confidence in the financial system, which in turn depends on
transparent and reliable information flows, the ethical and responsible
behaviour of financial intermediaries and the fair and non-discriminatory treatment
of consumers. The crisis revealed severe shortcomings and a pervasive lack of
market integrity, also highlighted by recent scandals and market abuses,
including the manipulation of interest rate benchmarks (LIBOR and EURIBOR). The
economic damage is difficult to quantify but it is likely to be large and in
excess of the billions of euros of record fines that banks had to pay. The
costs in terms of reduced confidence and trust in the financial system are not
quantifiable but are also likely to be significant.

The Commission
has therefore proposed a set of measures to enhance transparency of financial
markets. The financial reform agenda aims to restore trust in the financial
system and to significantly enhance market integrity. The reforms will benefit all
users of financial services, in particular customers, and investors.

The revised Market
Abuse Regulation and Directive on Criminal Sanctions for Market Abuse (MAR/CSMAD)[24] will
establish stricter rules to better prevent, detect and punish market abuse. The
Commission proposal for a Regulation on financial benchmarks seeks to enhance
the robustness and reliability of benchmarks and prevent their manipulation.[25]

A combination of
reform measures have been adopted or proposed to ensure that consumers and
retail investors have efficient, timely and non-discriminatory access to
financial services. Supervisory and regulatory authorities will ensure that
financial services providers do not exploit information asymmetries against
their customers’ interest. The measures provide in particular for the
establishment of EU-wide responsible mortgage lending standards;[26]
better information disclosure and higher standards for financial advice and
distribution;[27]
enhanced protection of the assets of retail investors;[28] more transparency
and comparability of bank account fees, the establishment of a quick and simple
bank account switching procedure and access to basic bank accounts.[29] These
measures will increase consumer trust in financial markets and products.

The Regulations on
Credit Rating Agencies (CRAs)[30]
are increasing the independence and integrity of the rating process and enhance
the overall quality of ratings. Complementary audit reforms will improve
the quality of statutory audits in the EU and, combined with reforms of the
international accounting standards that apply in the EU, will help rebuild
investor confidence in the financial system.[31]

3.5       Improving
the efficiency of the financial system

By addressing the
underlying market and regulatory failures, the financial reform agenda aims at improving
the efficient functioning of the financial system.

Improved disclosure
and reporting requirements in various reform initiatives increase the transparency
and reduce information asymmetries in the system for all market participants,
supervisors and consumers.

The
establishment of the Banking Union and the single rulebook
contribute to efficiency by levelling the playing field and facilitating
cross-border activities. Similarly, the reduction in implicit subsidies
for systematically important banks and proposed restrictions on the activities
of large complex and interconnected banks (i.e. structural reform) will help reduce
competitive distortions, correct related mispricing of risk and consequently
improve the functioning of the market and allocation of capital.

The improved
prudential framework for banks and the new risk-based capital requirements for
insurers in Solvency II, combined with improved risk management
standards, will induce financial institutions to better internalise the risk of
their activities and contribute to more efficient, risk-adjusted pricing.

The access
provisions contained in MiFID II, EMIR and the CSDR will reduce access
barriers to financial market infrastructures and promote competition along the
whole securities trading chain. In the same vein, the revised CRA Regulation
and the audit reforms facilitate market entry and increase the visibility
of new entrants.

The financial
regulation agenda strikes a balance between strengthening financial stability
and allowing a sufficient and sustainable flow of finance to the real economy. The
reform measures devote particular attention to small and medium-sized enterprises
(SMEs), given their particular difficulties in securing external finance
and their important role in creating employment and fostering sustainable growth.
The EU financial regulatory framework has been adapted considerably over the
last three years.[32]
The problems SMEs face with regard to accessing finance have been addressed
from different angles and include measures to ease access to capital markets to
raise capital directly,[33]
make lending to SMEs more attractive,[34]
and introduce new frameworks[35]
in the field of investment funds.

4.         The costs
of the reforms

Financial reform
leads to economic costs for financial intermediaries as it introduces
compliance costs and requires adjustments to the way business is conducted.
These costs have been estimated in the impact assessments of the legislative
initiatives and are discussed in more detail in the accompanying staff working
document. A significant part of these costs are adjustment costs during
transition. Overall, costs are expected to be more than offset by the
benefits of the enhanced stability and integrity of the financial system.

Costs to
financial intermediaries are inevitable and, to a certain extent, a sign of the
effectiveness of the reforms. For example, a reduction in the implicit subsidy
for certain large, complex and interconnected banks will increase their funding
costs but at the same time reduce the costs for taxpayers. Similarly, the reforms
induce a re-pricing of risk, which creates costs but these costs are matched by
the benefits of avoiding excessive risk-taking because of underpriced risk in
the market. Thus, costs to financial intermediaries are often compensated by
wider economic and societal benefits.

The transition
process to a more stable financial system is particularly challenging as
regards its potential impact on the real economy. However, the current
difficulties in the market and wider economy cannot be attributed to the
regulatory reforms (but rather the lack thereof). They relate much more to the
problems built up before the crisis and their consequences, including the
evaporation of trust in the market and related liquidity squeezes, weak bank
balance sheets, high private and public debt levels, low interest rates, the
recession and weak economic growth prospects.

In order to
minimize costs and potential disruptions during the transition, phasing-in
periods have been granted.[36]
Furthermore, where significant adverse effects have been anticipated, the rules
have been adjusted (e.g. the long-term guarantee package in Solvency II[37]) or,
under certain circumstances, exemptions have been granted (e.g. for
pension funds and non-financial corporates in EMIR). Where rules entered
uncharted waters, observation periods have been applied (e.g. with
regard to the leverage ratio and liquidity regulation of banks). Finally, ongoing
monitoring and review of all reforms will ensure that they deliver their
intended benefits while avoiding undesired effects including those arising from
interaction  between different reforms.

5.         Conclusions

Taken together,
the reforms proposed by the Commission to implement the comprehensive financial
regulation agenda agreed by the G20 and set out in the Commission's
Communications of 2009, 2010 and 2012 address the regulatory gaps and market
failures that were laid bare by the crisis.

Our proposed
reforms empower supervisors to oversee markets that had been beyond their
reach, and bring transparency for all market participants over activities
that were previously known only to a handful of insiders.

Our proposed
reforms establish ambitious new standards to limit excessive risk-taking
and make financial institutions more resilient. When risks nevertheless
materialise, the burden is shifted away from taxpayers to those who will
earn profits from activities giving rise to these risks.

Our proposed
reforms make financial markets work better in the interest of consumers,
small and medium-sized enterprises and the economy at large.

Our proposed
reforms put the onus on all actors including managers, owners, and public
authorities to ensure that financial institutions and market participants abide
by the highest standards of responsibility and integrity.

Overall, our
proposed reforms will help reduce the likelihood and impact of crises occurring
in the future. The financial system is already changing and improving in key
aspects. This is expected to continue as the reforms take further effect. But
the situation must be carefully monitored. As the economic situation is
changing, so are risks and vulnerabilities for the financial system. The
Commission will remain vigilant and proactive, preserving the overall
reform and responding to new risks and vulnerabilities as they emerge.

While the
reforms will give rise to some costs, many of these are transitory in
nature. Economic analysis and available evidence indicates that the total
expected benefits of the financial regulation agenda, once fully implemented,
will likely outweigh the expected costs. Phasing-in and observation
periods will help reduce the transition costs.

Much has been
achieved in a short time, but the reform process is not yet fully accomplished.
Some important reforms still need to be adopted by the co-legislators (e.g.
on bank structural reform, shadow banking, financial benchmarks). The
Commission calls on the Council and the European Parliament to give priority to
agreeing these proposals. Work in a few remaining areas is still under
preparation. In particular, work on a resolution framework for non-banks and to
address concerns in shadow banking is ongoing at EU and international level.

With the
majority of reforms agreed, the focus now moves to effective implementation
and consistent application of the new regulatory framework. Ongoing
monitoring and review is necessary to evaluate implementation and the overall
impact and effectiveness of the reforms. The Staff Working Document 'Economic
Review of the Financial Regulation Agenda' is a first step in this process. When
completing implementation of reforms, ensuring regulatory and supervisory
convergence between all major financial centres around the world remains a
significant challenge. The Commission will continue to promote an
internationally coordinated approach in the area of financial regulation and
expects its partners to implement their commitments effectively.

Going forward, political
attention must increasingly shift to tackle Europe’s need for long-term
financing and to develop a more diversified financial system with
higher shares of direct capital market financing and greater involvement of
institutional investors and alternative sources of finance. As set out in the
March 2014 Communication on long-term financing, addressing these issues is a
priority to reinforce the competitiveness of Europe’s economy and industry.[38]

[1] Report
of the High-level Group of Financial Supervision in the EU, 25 February 2009.

[2] Communication on
'Driving European recovery', COM(2009)
114 final.

[3] Communication on
'Regulating financial services for sustainable growth', COM(2010) 301 final

[4]
Communication on 'A roadmap towards a Banking Union', COM(2012) 510
final. Communication on 'A blueprint for a deep and genuine economic and
monetary union - Launching a European Debate', COM(2012) 777 final/2.

[5] The review only
covers financial regulation measures and not the other important reforms taken
in other areas in response to the crisis.

[6] See European Commission  State aid scoreboard 2013.

[7] See Regulations (EU)
No 1092/2010,1093/2010, 1094/2010, and 1095/2010 of the European Parliament and
of the Council of 24 November 2010; OJ of 15 December 2010, L 331, and Council
Regulation (EU) 1096/2010 of 17 November 2010; OJ L331/1 of 15.12.2010..

[8] The ESFS is subject
to a separate review.

[9] Council Regulation
(EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European
Central Bank concerning policies relating to the prudential supervision of
credit institutions.

[10] COM(2013)520

[11] Directive 2009/14/EC
of the European Parliament and of the Council  of 11 March 2009 amending
Directive 94/19/EC on deposit-guarantee schemes as regards the coverage level
and the payout delay

[12] Directive 2013/36/EU
of the European Parliament and of the Council of 26 June 2013 on access to the
activity of credit institutions and the prudential supervision of credit
institutions and investment firms, amending Directive 2002/87/EC and repealing
Directives 2006/48/EC and 2006/49/EC and Regulation (EU) No 575/2013 of the
European Parliament and of the Council of 26 June 2013 on prudential
requirements for credit institutions and investment firms and amending
Regulation (EU) No 648/2012

[13] COM(2012) 280

[14] COM(2011) 656,
COM(2011) 652

[15] Regulation (EU) No
648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC
derivatives, central counterparties and trade repositories

[16] COM(2012) 73

[17] Regulation (EU) No
236/2012 of the European Parliament and the Council of 14 March 2012 on short
selling and certain aspects of Credit Default Swaps

[18] See Communication on 'Shadow
Banking – Addressing New Sources of Risk in the Financial Sector', COM(2013) 614
final.

[19] Directive 2011/61/EU
of the European Parliament and of the Council of 8 June 2011 on Alternative
Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and
Regulations (EC) No 1060/2009 and (EU) No 1095/2010

[20] COM/2013/615

[21] Directive 2009/138/EC
of the European Parliament and of the Council of 25 November 2009 on the
taking-up and pursuit of the business of Insurance and Reinsurance (Solvency
II)

[22] Report of the High-level
expert group on reforming the structure of the EU banking sector (2012),
October.

[23] COM (2014) 43

[24] COM (2011) 651 and
COM(2011) 654

[25] COM (2013) 641

[26] Directive 2014/17/EU
of the European Parliament and of the Council of 4 February 2014 on credit
agreements for consumers relating to residential immovable property and
amending Directives 2008/48/EC and 2013/36/EU and Regulation (EU) No 1093/2010

[27] For example, COM(2012)
352.

[28] For example, COM(2012)
350.

[29] COM(2013) 266

[30]  Regulation (EU) No
462/2013 of the European Parliament and of the Council of 21 May 2013 amending
Regulation (EC) No 1060/2009 on credit rating agencies

[31] COM(2011) 779 and COM(2011)
778

[32] Communication on 'An
action plan to improve access to finance for SME's', COM(2011) 870 final

[33] Proposed Article 35
of MiFID

[34] Article 501 of
Regulation EU 575/2013 (CRD IV package)

[35] Regulation (EU) No
345/2013 of the European Parliament and of the Council of 17 April 2013 on
European venture capital funds and Regulation (EU) No 346/2013 of the European
Parliament and of the Council of 17 April 2013 on European social
entrepreneurship funds. See also COM/2013/462.

[36] E.g. for capital and
liquidity requirements in the CRD IV package.

[37] As amended in Omnibus
II. COM/2011/0008 final

[38] COM(2014) 168 final