The EU Legislative Process: From Directive Proposal to Consistent Application of the Regulatory Regime

Birgitte Bundgaard Madsen, Financial Markets

INTRODUCTION AND SUMMARY

The economic advantages of a single financial market in the EU have made financial integration a priority area. Initiatives to complete the single financial market have typically come in waves. At the end of the 1980s, the foundations for financial integration were laid by the liberalisation of capital movements and the second-generation directives that enabled financial enterprises to conduct cross-border activities on the basis of home-country supervision. The introduction of the euro accelerated the integration process and sharpened the focus on removing the remaining barriers. In 1999, the European Commission launched the Financial Services Action Plan (FSAP) that set out priorities for the work to complete the single financial market, particularly in the securities field^[1], and was aimed at eliminating regulatory barriers.

The work on FSAP revealed that the EU's general legislative process lagged behind the rapid pace of change in the financial sector. Furthermore, the work did not necessarily result in the degree of regulatory harmonisation which is a precondition for the single financial market. Against this background, in 2001 a new EU procedure, the Lamfalussy procedure, was established to speed up and enhance the flexibility of the legislative process. Since a single financial market in the EU not only requires a single regulatory regime, but also its consistent application, the Lamfalussy procedure also creates the framework for increased supervisory cooperation.

This article reviews how directives in the financial area are adopted under the new procedure. The adoption of the new capital-adequacy rules (Basel II) serves as an example. The article also reviews the development in supervisory cooperation within the EU, as well as the consi­stent application of the regulatory regime.

The Lamfalussy procedure has several advantages, especially the relatively speedy process of adoption of new legal acts. However, the resource-consuming procedure makes great demands of small member states, and there may also be a tendency for very intensive regulation.

NEW MODEL FOR ADOPTION OF FINANCIAL SERVICES LEGISLATION IN THE EU

The EU's legislative procedure is stipulated in the Treaty. The normal legislative procedure for financial regulation is that the Council, i.e. the Ecofin Council in respect of the financial area, and the European Parliament adopt directives under the co-decision procedure. In practice, the Commission's proposal is first considered by a working group under the auspices of the Council, in which all member states are represented. At the same time, the European Parliament is consulted. Once the Council's working group has completed its reading of the proposal, and political agreement has been reached in the Council, the proposal is submitted to the European Parliament. The European Parliament then submits its position with proposed amendments to be considered by the Council. After possible reconsideration by the Council working group and agreement in the Council, the proposal is re-submitted to the European Parliament for a second reading. Final adoption of the directive requires agreement on the text between the European Parliament and the Council. If agreement cannot be reached, a committee with representatives from both institutions can be established. If agreement still cannot be reached, the legal act is not adopted.

This process takes three to four years on average, sometimes longer. There are examples of directives that have been in the pipeline for more than 10 years, e.g. the UCITS Directive^[2]. Additional to this is the period of national implementation, which is rarely less than 18 months.

The co-decision procedure applies not only to the adoption of directives, but also to their amendment, including amendments of a purely technical nature. In view of the rapid pace of change in the financial area, regulation has tended to lag behind this progress.

In 2001, the Lamfalussy procedure^[3] was introduced to enhance the efficiency of the legislative process in the securities field within the framework of the Treaty. In 2002, the procedure was extended to the entire financial area. The legal basis for the Lamfalussy procedure is an interim agreement between the European Commission, the Council and the European Parliament. The rationale is that only the most important general framework principles should be adopted by the Council and the European Parliament under the co-decision procedure (level 1). The adopted framework principles should comprise implementing powers to issue more technical legal acts and amendments thereof, which are adopted by the Commission after consultation of the member states at official level in a number of committees (level 2). This division of the legislative process is also found in Denmark, where acts are adopted by the Folketing (Parliament) and executive orders are issued by ministries and agencies as empowered by the acts. In the EU, a number of super­visory committees are also established (level 3), comprising representatives of the national supervisory authorities, to advise the Commission on the preparation of proposed financial services directives. The supervisory committees also prepare proposals for level 2 regulation and contribute to consistent implementation of the rules in the member states. In addition to the legislative process, the Lamfalussy procedure also comprises recommendations for expanded cooperation and coordination among the national supervisory authorities at level 3, so as to enhance convergence in the supervisory approach. The Lamfalussy procedure is described in more detail in Boxes 1 and 2.

Chart 1 illustrates the timeline from the submission of proposals to the adoption of directives under the Lamfalussy procedure. The timeline shows the customary schedule for the process concerning a number of directives, e.g. the Prospectus Directive^[4] and MiFID^[5]. As the timeline in Chart 1 shows, several phases of the legislative process overlap. On the one hand, this ensures the required speed, but on the other it makes the model vulnerable to delays at the individual levels. The process to adopt the Prospectus Directive and especially MiFID illustrates how it can be necessary to extend the deadlines during the process.

NEW CAPITAL-ADEQUACY RULES FOR CREDIT INSTITUTIONS

One example of the new legislative procedure is the adoption of the new capital-adequacy rules, called Basel II^[6]. The work on the rules was initiated in 1999 under the auspices of the European Commission and proceeded concurrently with the preparation of the recommendations of the Basel Committee^[7].

On 14 July 2004, the Commission submitted a proposal for new capital-adequacy rules. In technical terms, the new rules were implemented in the EU regulatory regime via revision of the two existing directives in the area: the Banking Directive (2000/12) and the Capital Adequacy Directive (93/6). The amendments to the directives were subject to adoption under the co-decision procedure. To speed up the process, the European Parliament and the Council read the proposals simultaneously. In the Council, the proposals were considered by a working group with representatives from the member states. In the European Parliament, political agreement on the directive proposals was reached on 28 September 2005, while the Council reached agreement on 11 October 2005. The directives were formally adopted by the Council in June 2006.

The new directives set out the framework for the new capital-adequacy rules. According to the Lamfalussy procedure, the more technical provisions, primarily described in the annexes to the directives, may be amended by the Commission after consultation of the European Banking Committee (EBC), which is a level 2 committee.

Concurrently with the adoption process, the Committee of European Banking Supervisors (CEBS), which is a level 3 committee, was preparing common guidelines, standards and recommendations with a view to achieving convergence in the supervisory authorities' enforcement of the new rules in practice. This extensive work, which is still in progress, is undertaken by a large number of working groups.

In order to meet the deadline of 1 January 2007 for entry into force in the member states, the work on implementation of the new rules in Denmark was initiated concurrently with the adoption of the directives and the preparation of recommendations by CEBS. The Bill was submitted to the Folketing (Parliament) prior to the formal adoption of the directives.

The preparatory work for the directives under the special process has taken several years, but the actual adoption procedure has only taken approximately 2.5 years from the Commission's submission of the proposals to the entry into force. Compared to the adoption process for the previous capital-adequacy requirements, which took around 5 years, the process has been rapid.

Furthermore, the adoption of the capital-adequacy rules was characterised by a high degree of transparency in relation to the stakeholder organisations. During the preparatory work under the auspices of the Basel Committee and the Commission, and during the adoption process, consultation rounds were held on an ongoing basis. Five rounds of Quantitative Impact Study (QIS) were conducted among credit institutions, including a number from Denmark. CEBS has conducted ongoing consultation rounds on the preparation of the supplementary rules.^[8]

INCREASED SUPERVISORY COOPERATION

The new legislative process, the Lamfalussy procedure, is accompanied by extended cooperation and coordination among national supervisory authorities in the financial field in order to enhance convergence in supervisory methods. The impact of the legislation depends on how the rules are implemented, but to an equal degree also on how the super­visory authorities apply the legislation in practice. The 27 EU member states together have more than 60 supervisory authorities for credit institutions and markets. These national supervisory authorities have different objectives, mandates and supervisory powers. Under the Lamfalussy procedure, the supervisory structure in the EU is being changed via the introduction of supervisory committees (level 3) for the purpose of achieving convergence in regulation and supervision. The committees issue rules without a formal mandate to regulate. Instead, decisions are based on agreement, and compliance and cooperation are primarily voluntary for the authorities of the member states.

EXPERIENCE WITH THE LAMFALUSSY MODEL FOR ADOPTION OF LEGAL ACTS AND SUPERVISORY COOPERATION

There is a tendency for the duration of the process for the adoption of directives to be reduced. This is particularly apparent in the securities field, where the process of e.g. the Prospectus Directive took just over 16 months from submission of the proposal to adoption, compared to approximately 9 years for the previous directive. The Lamfalussy procedure has thus already proved its ability to speed up the legislative process concerning financial services, to the benefit of financial integration.

Chart 1 illustrates that as a consequence of the very tight deadlines for preparation of legislation, a number of level 2 and 3 processes must take place concurrently with the actual directive negotiations at level 1. With regard to the capital-adequacy rules, CEBS began its work on recommendations, etc. concurrently with the directive negotiations. In the securities area, the tight deadlines have led to several cases of level 2 regulation that is based on drafts of level 1 directives. For the member states, the technical level 2 regulation has sometimes been adopted very late in relation to their deadline for final implementation. As a result, the member states were obliged to initiate the national implementation process before the final rules were known. This applied especially to the MiFID process.

In connection with the adoption of the new capital-adequacy rules a large body of work was initiated in various sub-groups under CEBS. Much of this work took place simultaneously due to the very tight deadlines. This is extremely resource-consuming, especially for the supervisory authorities of the member states, and may be difficult for the small member states to honour. Denmark participates in a small number of working groups in this area.

The basis for the Lamfalussy procedure is that the Council and the European Parliament should solely adopt framework principles for legislation and empower level 2 to adopt regulations of a technical nature. It has proved difficult in practice to distinguish between framework principles and technical regulations. MiFID is an example of how regulation has on the one hand become more detailed, but at the same time has not resolved politically controversial issues, which instead were passed on to level 2 regulation. In addition, there is a tendency to add a large number of further rules at level 3, since the supervisory authorities in 27 member states also have to reach compromises on principles and rules for supervisory methods.

The continued success of the Lamfalussy procedure depends on rapid, accurate and consistent implementation of the regulatory regime.