Diplomatic and trade relations between Europe and the US may be somewhat frosty these days, but there’s one area where transatlantic bonhomie is at an all-time high: securities regulation. In January William Donaldson, chairman of the US Securities and Exchange Commission (SEC), paid a visit to Brussels to meet senior members of the committee of European Securities Regulators (CESR), a body of national regulators and the closest thing that the European Union has to an SEC-like watchdog. It was Donaldson’s first European tour of duty since assuming the SEC Chairmanship in early 2003. What was striking was that he used the visit to reverse recent unilateralist American policy in securities regulation, fixing his focus firmly on teamwork.
Reforming securities regulation across the EU is far from a done deal. The debate now is whether Europe will end up with too little, too late.
In a 3,000-word keynote speech announcing the start of a working relationship with CESR, Donaldson used the word “collaboration” five times and “co-operation” a dozen times. The chairman even hinted at the possibility of mutual recognition, which would allow stocks regulated under European rules to be admitted on US markets.
It was a landmark speech for regulators on both sides of the Atlantic. Formerly, any public talk of mutual recognition had been a “complete no-no,” notes Paul Arlman, secretary general of the Federation of European Stock Exchanges.
But it didn’t come as a complete surprise to Arthur Docters van Leeuwen, who’s been chairman of CESR (pronounced “Caesar”) since it was founded in 2001 as part of the EU’s Financial Services Action Plan (FSAP). A few months earlier he’d met Donaldson and other SEC officials at their headquarters in Washington, DC, where they laid the groundwork for greater co-operation. Yet Docters van Leeuwen was understandably pleased with Donaldson’s speech in January. “[His] coming here and using those terms was gratifying,” he recalls today from his home in The Hague. As he notes, there’s a new-found sense of kinship. “When I asked why we should collaborate on Capitol Hill last October, the best answer came from Maryland Senator Paul Sarbanes: ‘We are both big economies but we are connected. We can see that when a few people really misbehave then both markets shiver’.”
So does the recent rapprochement mean that CESR is positioning itself to become Europe’s de facto SEC? If so, it’s a move welcome in many European business circles. In an on online poll in February of CFO Europe readers, nearly 75% of respondents said that Europe needs a single securities market super-regulator.
Others agree. As Jonathan Marsh, head of the financial services and markets group at Hammonds, a UK-based law firm, puts it: “There’s more appetite for a pan-European FSA [the UK's enforcer] than just another talking shop for European regulators.”
Some critics of the current approach even go so far as to say that the EU’s current fragmented approach to regulation, in which individual national regulators have autonomy in implementing European Commission-approved directives, makes it a soft target for corporate malfeasance—Parmalat being the most recent example.
Yet building an SEC-like body for Europe isn’t done lightly. The big debate now is whether CESR can, or indeed should, evolve from its current consulting role into an umbrella organisation that has the regulatory might to regain and sustain investor confidence in Europe’s capital markets.
So far, CESR’s track record has been promising. Designed to steer the EU through the tricky execution of Baron Lamfalussy’s FSAP of 1999, CESR has helped the Commission hammer out a handful of directives that will have a big impact on corporate Europe. For CFOs, the most noteworthy are the Prospectus Directive (whereby when a prospectus for a company issuing equities or bonds is approved in one member state, it will be able to market to investors in all member states) and the Transparency Directive (which aims to standardise the information that issuers must disclose).
But to say that CESR is low-key is an understatement. Even now, two-and-a-half years since its formal launch, few people outside the small coterie of exchange officials have even heard of it. Docters van Leeuwen admits he still has a hard time selling the idea of a “virtual network” of regulators. “People normally think of a huge building with nice floors and wood and steel, with lots of people inside working very hard. I still get asked, ‘Where the hell is this CESR, and where does it come from?’”
CESR is certainly on a very different footing from the SEC, which was set up under radically different circumstances. Founded in the 1930s in the wake of the Wall Street crash that led to the Great Depression, the SEC today has over 3,100 staff, and its 2003 budget—entirely publicly funded—was $716m (583m). The SEC also has powers to impose financial sanctions on wrongdoers, and has a long history of co-operating with the US Department of Justice to bring criminal prosecutions for violations of securities laws.
By contrast, as an advisory group to the commission, CESR has no constitutional powers. Funded by annual subscriptions from members, it’s run on a tight budget of 2.2m a year from spartan offices in Paris, with a permanent secretariat of only 14 people.
The committee nominates its own chair and vice-chair, who are elected by secret ballot every two years. Docters van Leeuwen was re-elected for a second term last autumn. A self-confessed “jack of all trades,” the jovial 58-year-old Dutchman has divided his career into roughly seven-year stretches, including spells as attorney general of the Netherlands and head of the Dutch secret service (he was in the latter job during the fall of the Berlin wall). In 1999 he took up his current day job, the executive chairmanship of the Authority for Financial Markets in the Netherlands.
The committee he chairs is made up of delegates from each EU member state. There’s also a seat at the table for Alexander Schaub, director general of the Internal Market Directorate-General at the commission, and chairman of the European Securities Committee (ESC), an influential forum of representatives of EU economic and finance ministries based in Brussels. The full committee met five times in 2003, while sub-groups on individual directives got together more frequently.
Against this backdrop, CESR officials have every reason to be upbeat about what they’ve achieved to date, says Norbert Walter, chief economist at Deutsche Bank and a member of the Inter-Institutional Monitoring Group, a body set up by the EU to watch over the progress of Lamfalussy’s project. According to Walter, CESR hasn’t fallen victim to the infighting or horse-trading that characterises many EU-led initiatives. “There’s really been a strong will of the people sitting in CESR to get on with the job, and to search for ever- better methods to get different views understood.”
The chairman receives such plaudits graciously, with a wave of the hand. He notes that most of the member state regulators already had regular contact with each other before CESR. Once the new body was launched, the members “didn’t waste too much time haggling about our physical location, the chairman or the budget,” he says. Low-profile it may be, but “the machine is working.”
Crossing the Rubicon
But is this a machine equipped to serve as Europe’s counterpart to the SEC? The question is especially pertinent now because CESR is at a critical juncture. Having completed the bulk of the advice on primary legislation, CESR’s focus is about to shift to implementation and enforcement, working with member states to ensure a consistent interpretation of the directives it helped to craft.
This will be the acid test. As Kaarlo Jännäri, director general of the Finnish Financial Supervision Authority and CESR’s vice-chairman, observes, ultimately, CESR’s success will be measured not by acting as the consulting arm of the commission but “by concrete results in terms of increased cross-border business. We must move beyond paper and words and see real and effective implementation.”
But some observers see trouble ahead. According to Tom Troubridge, head of the capital markets group at PricewaterhouseCoopers in London, there’s a conflict of expectations brewing between CESR and politicians in member states. Troubridge notes that in the UK, for example, a number of witnesses to a House of Lords Select Committee on the EU convened in November last year—including ministers from the UK and France—expressed the hope that legislation produced under the FSAP would allow member states some flexibility in interpretation. That puts them on a collision course with CESR, “which is looking for maximum harmonisation and will face a real problem in seeking uniformity across 25 member states,” says Troubridge.
And looking further ahead to the enforcement phase of CESR’s mandate, others predict more tension. One such doom-merchant is Ruben Lee, adjunct professor at the University of Reading’s Business School for Financial Markets. CESR has been “a major political success” until now, he says, noting that it has been consulting effectively and treading a fine path “through the Byzantine complex of power politics between the Council of Ministers, the European Commission, the European Parliament, member state governments and national securities regulators.” But its useful days will soon be over: as a loose affiliation of regulators, CESR is simply not capable of providing effective pan-European enforcement, he asserts.
Lee reckons CESR will gradually accrue powers, bringing it closer to the SEC model over time. Although it would stop short of sanctioning offenders like the SEC—because of Europe’s multiple civil, administrative and criminal law jurisdictions—this “ESEC” would be allowed to investigate possible infringements and make its findings and recommendations public. Such so-called soft enforcement “will provide incentives for member states to undertake corrective action,” Lee predicts.
While not everyone shares Lee’s vision, many sense that CESR will have to bulk up in the near future in order to cope with the added burden of implementation and enforcement. David Devlin, president of the Brussels-based Federation of European Accountants, says there’s need for more hands both at CESR and at DG Internal Market (where there are just ten members of staff under Schaub). “It’s all very well, post-Parmalat, talking about more regulations, but what we need to make sure is that they are effectively applied, and that sufficient resources are given to it to ensure very strong co-ordination and co-operation,” he notes.
Keeping the Faith
Plenty of others, meanwhile, prefer to reserve judgement. They stress that CESR must be given time to see if it can indeed provide the supervisory framework that will enable a single market to flourish. “Observers should not look too critically at something that’s that new,” says Ethiopis Tafara, director of international affairs at the SEC. “You have to give it time to live and breathe, and see whether it will accomplish what it is designed to accomplish.”
For his part, Docters van Leeuwen bristles at attempts to plot CESR’s future. Trying to guess what kind of body will be needed to regulate an integrated market is missing the point, he maintains: “It’s not so much a question of how CESR will develop, as how the fundamentals in the markets will develop.” For example, he says, Europe does not have a large mass of retail investors who think in terms of cross-border transactions—if that changes, CESR will have to be able to respond. “I’m a man of a practical bent. We should adapt to what the markets ask from us, rather than the other way around.”
Whether such a wait-and-see philosophy is at odds with the kind of leadership demanded by an integrated market, only time will tell. One thing’s for sure—in the months and years ahead, CESR is going to have to do more than rely on that reservoir of good faith to win over the sceptics.
Four Steps to Heaven
A single, integrated market in financial services in the EU has been a long time coming. Way back in 1957, the Treaty of Rome dreamed up a market with the free movement of capital and services. Since then, we’ve seen an enquiry into why an EU-wide securities market has not developed at least once every decade.
But Baron Lamfalussy’s Committee of Wise Men look to have changed all that. By recommending a four-stage process for financial services reform, they’ve sped up the process of agreeing directives while improving the effectiveness of consultation. “Before Lamfalussy, there was a terrible sense that things took three to five years to get through,” notes Jonathan Marsh, head of financial services and markets group at Hammonds, a UK-based law firm. “Things have moved on a lot since.”
CESR’s role in the process is critical. At Level 1, the Commission puts forward a broad proposal for a directive or regulation, and the European Council and Parliament then decide whether to adopt it. Level 2 is the “comitology” procedure, where CESR, having consulted with market players, advises the Commission on any detailed implementing measures required. The Commission then makes a formal proposal to the European Securities Committee (ESC), a group of representatives from EU economic and finance ministries, which has three months to vote on it. Level 3 is implementation—CESR works with member state regulators to ensure a consistent interpretation and implementation of Level 1 and Level 2 measures. Enforcement comes at Level 4, where the Commission checks the compliance of each member state, and takes legal action where necessary.
Here’s a progress check on five of the key elements of the Financial Services Action Plan, and on market reaction to date.
Market Abuse Directive
Establishes common EU-wide standards against insider dealing and market manipulation, and ways to handle the disclosure of price-sensitive information. Adopted by Parliament in December 2002, it came into force in April 2003 and is due to be implemented in member states in October 2004.
Most observers are satisfied with the content of the directive, and the way in which it was steered by rapporteur Robert Goebbels, socialist MEP for Luxembourg. The only gripes have been to do with the time allowed by CESR for consultation with market practitioners. A second consultation in late 2002, for example, gave industry exactly four days to react to a revised draft. Granted, notes Lachlan Burn, a partner at law firm Linklaters in London, CESR’s hands are often tied by delayed delivery of mandates by the Commission, which in turn is kept waiting by Council and Parliament. But that’s led to compressed timetables. The IIMG, a group set up to monitor working relations within the Lamfalussy project, now recommends that CESR allocate three months to market consultation for each given mandate.
Aims to establish information requirements for equity and bond issuers in Europe, so that once a company’s prospectus is approved in one member state, it will be able to market to investors in all member states. Adopted in July last year, it came into force in December. Member states have until July 2005 to implement.
Ambitiously billed as a “maximum harmonisation” directive in order to achieve the goal of common standards, this directive has had a troubled history in the hands of Liberal Democrat MEP for southeast England, Chris Huhne. And reaction to the finished article has been lukewarm at best. Paul Arlman, secretary general of FESE, the Federation of European Securities Exchanges, doesn’t mince his words: “It’s a brick”. He bemoans what he calls an entassement—a disorderly accumulation of national standards resulting in an unwieldy mess. “It was a case of too many people involved who wanted to keep all kinds of national particularities in the common text,” he says. He notes that early drafts contained a separate section of special provisions for shipping companies, for example, inserted at the insistence of Greeks and Norwegians.
Linklaters’ Burn blames CESR’s teething problems more than anything else. “What you had was a group of regulators from different countries getting together pretty much for the first time, all of them bringing different experience of cross-border markets to the table,” he says. In that context, it was unsurprising that “you found all sorts of odd things creeping in, because a member from Ruritania thought it was important.”
Seeks to enhance comparability and market liquidity by standardising the information that issuers must disclose on an ongoing basis. The Council has agreed a draft of the directive, and the European Parliament voted on it in February 2004.
Unlike the Prospectus Directive, this directive is not focused on harmonisation—it will allow member state governments some flexibility to impose additional requirements above the minimum levels required. For example, on the controversial issue of quarterly reporting, the latest proposal from Ecofin is that there will be only very basic disclosure obligations on issuers between the annual report and the half-year report. “This isn’t a topic that requires a particularly religious conviction,” says Alexander Schaub, director general of DG Internal Market, and chairman of the ESC. “For me, it’s one where we can live with diversity and see how the conviction within the integrated market will develop.”
Markets in Financial Instruments Directive
Formerly known as ISD2, this will replace the existing Investment Services Directive which was implemented in 1995. Its main purpose is to provide a framework for stock exchanges and investment banks to operate on a pan-European basis. An overhaul was needed because the existing regime has been complicated by member states imposing local requirements on incoming cross-border operators.
Seen as the centrepiece of the FSAP, the directive has been much delayed by debate as some member states have opposed various pre-trade transparency requirements. It’s now subject to a second reading in the European Parliament by 1st May, before a final text is agreed.
Use of International Financial Reporting Standards
This is the work of CESR-Fin, a sub-committee chaired since November last year by John Tiner, CEO of the UK’s Financial Services Authority. The group co-ordinates the work of CESR members in the endorsement and enforcement of financial reporting standards in Europe.
The group has produced two standards so far. Standard No 1, released last April, set out 21 basic principles establishing common definitions of enforcement, and the kind of actions that might be adopted in case of infringement. “It’s a great step forward,” nods Ian Wright, global head of reporting at PricewaterhouseCoopers. “It brings clarity for member states as to what minimum principles should be applied.”
Standard No 2, published in October, called for a harmonised approach to enforcement decisions to include relevant non-securities regulators, and the establishment of an EU-wide database which would collate decisions taken by national enforcers. It also issued recommendations on conversion to IFRS that go beyond the official requirements of IFRS1. For example, the standard encourages companies to provide narrative information in their 2003 national GAAP statements on the expected differences in accounting policies, so as to ready investors for the first IFRS-compliant statements a year later.