ESMA and Brexit: a European super regulator in the making?

Publication November 2017


The European Securities and Markets Authority (‘ESMA’) is undoubtedly an important European institution. In addition to fostering supervisory convergence it is also a regulatory supervisor in its own right, directly regulating credit rating agencies and trade repositories. Its influence and standing in the European supervisory architecture is being further enhanced by MiFID II / MiFIR, for example in relation to product intervention and position limits.

However, the growth of ESMA’s powers are not limited to MiFID II / MiFIR and recent legislative proposals concerning central counterparties (CCPs) and the revision of the European System of Financial Supervision (ESFS) have led to questions in some parts of the market as to whether or not the European Supervisory Authority is in fact becoming a European ‘super regulator’ in the post Brexit landscape.

In this article we discuss the recent legislative proposals mentioned above and ESMA’s work so far on Brexit focussing on the relocation opinions that were issued during the summer. We then set out our view as to whether or not ESMA is becoming Europe’s super regulator.

EMIR review

The European Market Infrastructure Regulation (EMIR) review proposals are the culmination of the work that the European Commission (Commission) carried out in 2015 and 2016 which included a public consultation and a general report on the Regulation. The first set of amendments were published by the Commission in May 2017 and set out changes in the areas of reporting requirements, non-financial counterparties, financial counterparties and pension funds. The second set of proposals were published in June 2017 and set out changes as to how EU and third country CCPs are supervised.

The Commission’s rationale for the second set of proposals was summed up by Valdis Dombrovskis, Vice President responsible for Financial Stability, Financial Services and Capital Markets Union, stating, “The continued safety and stability of our financial system remains a key priority. As we face the departure of the largest EU financial centre, we need to make certain adjustments to our rules to ensure that our efforts remain on track.”

The second set of EMIR review proposals, which take the form of a draft Regulation, would grant ESMA significant new powers in respect of third country CCPs and EU CCPs.

For CCPs established in the EU, Member State supervisors will exercise supervision in agreement with ESMA. Critically, a new CCP Executive Session within ESMA will be established for these purposes. Existing colleges of national supervisors established under EMIR for each EU CCP will continue to act as bodies fostering cooperation. However, the head of a new CCP Executive Session will chair the existing EMIR colleges. The CCP Executive Session will be established within ESMA. The CCP Executive Session will consist of several permanent newly-appointed independent members, together with the relevant Member State supervisors responsible for the CCP concerned and the relevant central bank(s) of issue and the Commission as a non-voting member.  The CCP Executive Session will make decisions by a simple majority of its members, and its head is to have a casting vote in case of a tie.

As is currently the case the Commission will determine the equivalence of third-country CCPs. However, a two tier system for third country CCPs will be introduced:

  1. non-systemically important CCPs will be known as ‘Tier 1 CCPs’ and will continue to operate under the existing EMIR equivalence framework; and
  2. systemically important CCPs will be known as ‘Tier 2 CCPs’ and be subject to stricter requirements.

CCPs that have already been recognised under the current EMIR regime will continue to be recognised as Tier 1 CCPs until ESMA has determined that they are a Tier 2 CCP. ESMA will decide if a third country CCP is a Tier 2 CCP by assessing a number of aspects of the third-country’s CCP’s business. The determination will be based on four criteria:

  1. the nature, size and complexity of the third-country CCP’s business;
  2. the effect that the failure of, or a disruption to, the third-country CCP would have on the financial stability of the EU;
  3. the third-country CCP’s clearing membership structure; and
  4. the third-country CCP’s relationship, interdependencies, or other interactions with other financial market infrastructures.

However, at the moment the above criteria have no quantitative thresholds or metrics. The Commission, in cooperation with ESMA and the European System of Central Banks, will specify the exact criteria in a Delegated Act which is planned to be adopted within six months of the entry into force of the draft Regulation.

Furthermore there are four additional requirements that Tier 2 CCPs must fulfil:

  1. on-going compliance with the relevant and necessary prudential requirements for EU-CCPs as set out in Article 16 and in Titles IV and V of EMIR;
  2. written confirmation – within 180 days – from the relevant EU central bank of issue that the third-country CCP complies with any requirements imposed by that central bank. Such requirements could be imposed by the central bank in the exercise of its monetary policy tasks and may concern the availability and specific type of collateral held within a CCP;
  3. there must be written consent by the third-country CCP that ESMA may access its business premises on request and access any information held by it; and
  4. the third-country CCP must have all necessary procedures and measures in place to be able to comply with the first and third condition above.

The proposals further provide that cooperation arrangements between ESMA and third-country supervisors must be effective in practice and include the third-country supervisors’ agreement to allow investigations and on-site inspections and specify the procedures necessary for the effective monitoring of regulatory and supervisory developments in the third country. Arguably, Tier 2 CCPs will be co-supervised by their third-country home supervisor and ESMA.

The Commission’s proposals also introduce a further category of third country CCP, the ‘substantially systemically important CCP’. A third country CCP will have this designation if it is of such systemic importance for the EU or one or more of its Member States that the additional requirements for Tier 2 CCPs are insufficient to mitigate the potential risks to EU financial stability.

ESMA has an important role to play in this designation. ESMA, in agreement with the relevant central bank, will make a recommendation to the Commission as to whether a CCP is of substantial systemic importance. Where a Commission adopts an implementing act declaring that the CCP is substantially systemically important it will have to establish itself in the EU and apply for authorisation in a Member State in accordance with the requirements set out in EMIR.

ESMA is to regularly review the recognition of third-country CCPs as well as their classification. Such reviews are to take place every two years and more frequently where necessary. ESMA is also given powers to fine a third-country CCP for any infringements of the draft Regulation whether or not they are intentional. Where a Tier 2 CCP has committed an infringement, either intentionally or unintentionally, ESMA can apply a range of enforcement measures including withdrawing the third-country CCP’s recognition.

The EMIR review proposals are now in trialogue, being scrutinised by the European Parliament and the Council of the EU. At the time of writing it was reported in the press that some of the Commission’s proposals were being toned down but only time will tell as to what the draft Regulation will eventually look like. As for timing, it is generally expected that the proposals will take effect before the end of 2019 although this depends on how the negotiations go.

ESFS review

The ESFS consists of the three European Supervisory Authorities (ESAs) and the European Systemic Risk Board.  On 20 September 2017, the Commission issued legislative proposals that sought to change the structure of the ESFS and, in particular, significantly extend ESMA’s role in EU financial markets. The Commission press release that accompanied the legislative proposals contained a quote from Valdis Dombrovskis explaining the reasons behind them, “Financial markets are changing fast. We are seeing renewed cross-border integration, new opportunities in FinTech and a boom in sustainable and green finance. The EU needs to act as one player so that we can stay ahead of the curve. More integrated financial supervision will make the Economic and Monetary Union more resilient. These pragmatic proposals will also make it easier for our companies to operate cross-border and build consumer trust.”

Under the proposals the three ESAs will have a stronger coordination role. The ESAs will set EU-wide supervisory priorities, check the consistency of the work programmes of individual Member State supervisors with EU priorities and review their implementation. The ESAs will also monitor Member State supervisors’ practices in allowing market players – such as banks, fund managers and investment firms – to delegate and outsource business functions to non-EU countries. The governance and funding of the ESAs will also change under the proposals so that they can take decisions more independently from national interests. As the Commission’s press release stated under a proposed updated governance system, “newly-created Executive Boards with permanent members will lead to quicker, more streamlined and EU-orientated decisions”. The proposals will also make the ESAs funding independent from national supervisors.

In terms of extended direct capital markets supervision by ESMA the proposals provide that:

  • ESMA will authorise and supervise the EU’s critical benchmarks (such as EURIBOR and EIONIA) and endorse non-EU benchmarks for use in the EU;
  • ESMA will be in charge of approving certain EU prospectuses and all non-EU prospectuses drawn up under EU rules. ESMA will also be able to control advertisements for offers of securities or requests for admission to trading for which it approved the corresponding prospectus;
  • ESMA will authorise and supervise certain investment funds with an EU label – European Venture Capital Funds, European Social Entrepreneurship Funds and European Long-Term Investment Funds;
  • ESMA to have the right to act in market abuse cases where certain orders, transactions or behaviours give rise to well-founded suspicion and have cross-border implications or effects for the integrity of EU financial markets or EU financial stability;
  • the product intervention powers that are set out in MiFIR will be extended to cover fund managers, in addition to MiFID II firms and credit institutions;
  • the MiFIR transaction reporting obligation will be amended and investment firms will have to report transactions to ESMA, as opposed to Member State supervisors. ESMA will have to make transaction reports available to Member State supervisors; and
  • the authorisation and supervision of data reporting service providers (DRSPs) moves from MiFID II to MiFIR and ESMA becomes the competent authority for the purposes of the authorisation and supervision of Approved Publication Arrangements, Approved Reporting Mechanisms and Consolidated Tape Providers. The Commission proposes a three year transitional period for the transfer of power.

ESMA sector specific opinions on relocations

In July 2017, ESMA published three opinions setting out sector-specific principles in the areas of investment firms, investment management and secondary markets that the ESA said were designed to foster convergence in the areas of authorisation, supervision and enforcement in relation to relocations from the UK. The opinions followed an earlier ESMA opinion published in May that set out nine high level principles on relocations from the UK.

All three opinions were addressed to the competent authorities of the EU27 and assumed that the UK would become a third country after its withdrawal from the EU. The power to issue the opinions was provided for in Article 29 of the Regulation establishing ESMA which calls on the ESA to play an active role in building a common EU supervisory culture and allows for, among other things, the issuance of opinions to Member State competent authorities. This point was reinforced in the opinions themselves where it was noted that the EU27 have a “shared interest in building a common approach” to relocations and the accompanying press release added that those firms relocating must be “subject to the same standards of authorisation and ongoing supervision across the EU27 in order to avoid competition on regulatory and supervisory practices between Member States.”

Among other things, ESMA stated in its opinion on investment firms that EU27 national competent authorities (EU27 NCAs) should require applicants to provide them with a complete set of information as required under the MiFID framework and should carry out the complete authorisation procedure without any derogations or exemptions. Also, reliance on previous or existing authorisation would not be allowed on the basis that it was not provided for under the MiFID framework. The same reason was given for the non-applicability of transitional provisions and that EU27 NCAs could not rely on mere confirmation from applicants but instead “require detailed information in order to be satisfied that applicants’ organisational set-up and business operations will be in compliance with the MiFID framework from day one.”

Another important theme that appeared in the opinion on investment firms was the so-called substance requirements, where the ESA repeated previous concerns regarding letter-box entities and called on the EU27 NCAs to ensure that appropriate human and technical resources as well as adequate governance and internal controls are dedicated in the newly located firm. In terms of outsourcing arrangements, which was a particular focus of the opinion, EU27 NCAs were called on to properly monitor them, ensuring their full compliance with the MiFID framework and other regulatory requirements including EU data protection restrictions on data transfer outside the EU.

Among the comments that appeared in the opinion on investment management were those relating to white-label business. Interestingly, ESMA stated that EU27 NCAs should give ‘special consideration’ to entities engaged in this type of business noting that they may gain additional business as a result of the UK withdrawing from the EU although this might create ‘additional operational risks’. EU27 NCAs were called on by ESMA to assess whether entities would continue to have sufficient human and technical resources to manage the additional business and comply with applicable delegation requirements. ESMA further added that a “significant rise in the value of assets under management, managing new types of investment strategies or asset classes and/or investing in or distributing to new geographical regions will typically create the need for additional human and technical resources with the required experience and expertise and necessitate a higher sophistication of governance structures and internal control mechanisms.”

Delegation was also an important feature of the opinion on investment management. In relation to the assessment of the delegation arrangements EU27 NCAs should ensure that the delegation and/or operational risk management policies and procedures of entities detail all the functions set out in Annex II of the UCITS Directive and Annex I of the Alternative Investment Management Directive (AIFMD) that are not performed internally and are therefore subject to delegation requirements. ESMA also stated that EU27 NCAs should be satisfied that there are objective reasons for the delegation. This would require the EU27 NCAs to assess the: (i) detailed descriptions; (ii) explanations; and (iii) evidence of the objective reasons provided by authorised entities and be satisfied that the entire delegation structure was based on objective reasons. In order to do this ESMA said that the EU27 NCAs should carry out a ‘case-by-case’ analysis taking into account the materiality of the delegated activity. In terms of delegation to non-EU entities (for example the UK) ESMA noted that oversight and supervision of the delegated functions could be ‘more difficult’, the same would apply where delegation structures had longer or more complex operational chains. EU27 NCAs were called on by ESMA to give ‘special consideration’ to such arrangements and be satisfied that they were justified for objective reasons.

In terms of where the entity delegates portfolio management or risk management activities to non-EU entities (for example the UK) EU27 NCAs had to be satisfied that:

  • the entities to which portfolio management or risk management activities that were delegated were subject to regulatory requirements on remuneration that were equally effective as those applicable under the ESMA guidelines (the ESMA guidelines on sound remuneration policies under the AIFMD and the ESMA guidelines on sound remuneration policies under the UCITS Directive); or
  • appropriate contractual arrangements were put in place with entities to which portfolio management or risk management activities had been delegated in order to ensure that there was no circumvention of the remuneration rules set out in the above ESMA guidelines. Such contractual arrangements to cover any payments made to the delegates’ identified staff as compensation for the performance of portfolio or risk management activities on behalf of the authorised entity.

ESMA also called on EU27 NCAs to conduct ‘additional scrutiny’ where relocating entities were not dedicating at least three locally based full time employees to the performance of portfolio management and/or risk management functions and/or monitoring of delegates. This would apply even to those smaller entities employing simple investment strategies and having a limited range of business activities. Whether or not ‘additional scrutiny’ is in reality a prohibition remains to be seen, if that were the case it would be queried whether ESMA was exceeding its powers.

In the opinion on secondary markets ESMA makes the general point that EU27 NCAs should ‘raise awareness’ that current outsourcing arrangements with service providers based in the UK will need to be reassessed once the UK withdraws from the EU.

ESMA also states that:

  • outsourcing activities to service providers outside the EU27 could make the oversight and supervision of the outsourced activity more difficult. In the case of relocation to the EU27, “ESMA expects [EU27] NCAs to assess outsourcing arrangements with third-country service providers in order to ensure that there are no potential detrimental effects to investor protection, orderly markets or financial stability. Where the [EU27] NCA considers that such detrimental effects do exist, the trading venue should not be allowed to outsource the activity”;
  • EU27 NCAs should ascertain that outsourcing arrangements do not alter the responsibilities of board members and senior management in relation to the compliance of the EU27 trading venue with EU law. Any outsourcing that results in the delegation by senior management of its responsibility, alters the relationship and obligations of the trading venue to its members and participants, removes or significantly modifies the conditions subject to which the trading venue’s authorisation was granted should not be allowed; and
  • the admission to trading of financial instruments, the establishment of and any subsequent changes to the rulebook of the trading venue as well as the suspension and removal of financial instruments from trading and mechanisms to halt trading are key activities that should not be outsourced outside the EU27. Also, in relation to suspensions and removals of financial instruments and trading halts are concerned, EU27 NCAs should ensure that the primary persons responsible are available in the EU while the technical arrangements for triggering suspensions, removals and trading halts can be located outside the EU27.

Steven Maijoor speech

On 17 October 2017, ESMA’s chairman, Steven Maijoor, gave a speech on the challenges facing European financial markets. Unsurprisingly Brexit and supervisory convergence were both discussed. Interestingly, on the topic of supervisory convergence Mr Maijoor stated the following which implies that supervisory convergence is more than just ensuring that EU regulators are singing from the same hymn sheet in terms of regulatory rules. He stated, “supervisory convergence is not just about ensuring consistent supervisory approaches and outcomes. It also aims at making it easier and smoother for market participants to do business in the EU. Supervisory convergence means consistency across countries – and achieving this means that remaining barriers to cross-border business can be removed, and a truly integrated EU financial market can be created.”

On Brexit Mr Maijoor stated that ESMA would “monitor closely the risks associated with a withdrawal without appropriate arrangements and, if needed, identify possible mitigating actions”.  He added that ESMA had also asked credit ratings agencies and trade repositories for “their contingency plans to ensure that their post-Brexit set up complies with the relevant legislation.”

Perhaps on a more positive note Maijoor also said that “the UK will not become your average third country” recognising that the UK makes up about two thirds of EU equity trading and that this would not change in the near future.


The legislative developments described above show that ESMA’s scope and powers are being significantly extended and one would assume that further opinions on Brexit related matters are in the pipeline as the UK/EU negotiations start moving to a critical phase. Interestingly, the official EU line behind these developments are the protection of financial stability although Mr Maijoor has also mentioned that it is intended to make it easier and smoother for market participants to do business in the EU.

However, the developments should also be viewed as part of the general move away from national discretion in many parts of EU financial services legislation. MiFIR is a good example of this as it is directly applicable Regulation but perhaps more importantly are the numerous directly applicable technical standards that supplement MiFID II and MiFIR. This move reflects a desire to build a Single European rulebook for EU financial markets in a similar way that the EU authorities have built a Single European rulebook for prudential requirements. Increasing ESMA’s powers are an important part of this.

So in conclusion it appears to the author that ESMA is becoming Europe’s super regulator in the post Brexit landscape.

But these developments should really come as no surprise. In February 2012 the then Chief Executive of the FSA, Hector Sants gave a speech at the Cityweek Conference called ‘Update on the regulatory reform programme & European issues’. In his speech Sants’ spoke of the UK becoming a ‘supervisory arm’ of Europe and that the then FSA Handbook would gradually disappear in light of the Commission’s preference for Regulations as opposed to Directives. He also gave the following warning:

“On the question of harmonising the way supervisors conduct supervision, there is obviously momentum to have a common supervisory procedural manual. I support the importance of the ESAs having a role in maintaining standards and in doing so they need to be able to participate in peer reviews and have a full understanding of the way a supervisor assesses risk. However, I continue to believe that supervision needs to be delivered locally and be tailored to a particular set of circumstances. Good supervision needs to be based on forward-looking judgments and a deep understanding of firm-specific circumstances. We need to be careful that the philosophy of harmonisation does not undermine this principle.”

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