European law-makers are overhauling the way in which the financial system and the firms that operate within it are supervised. Writer Michael Imeson

What is it?

The EU is about to strengthen the system of financial supervision. Banks, insurers, fund managers and other firms are in broad acceptance but continue to oppose specific EU regulations that threaten their industries.

Who dreamed it up?

The Internal Markets and Services Directorate-General of the European Commission. It published its proposals in May, which were agreed by the European Council of Ministers in June. The Commission gave all interested parties until July 15 to comment. It will introduce legislation in the autumn and expects the new architecture will be operational next year. The proposals are based on a report published earlier this year by a high-level group chaired by Jacques de Larosière.

What are the main provisions?

The creation of a European Systemic Risk Board (ESRB) and a European System of Financial Supervisors (ESFS) containing three new European supervisory authorities. The ESRB will monitor and assess risks to the stability of the financial system as a whole - 'macro-prudential supervision'. It will provide early warning of systemic risks building up and make recommendations for dealing with them. The ESFS will supervise individual financial institutions - 'micro-prudential supervision'.

The plans for improved financial supervision are in addition to a range of regulations recently proposed by the Commission which threaten to overwhelm firms. These include a draft directive on alternative investment fund managers, proposed rules on derivatives markets and executive pay, and measures to counter the pro-cyclical effects of regulatory standards.

What's in the small print?

The new supervisory authorities will have binding powers to settle disputes between national supervisors and to impose a single European rule book, which will limit the power of national supervisors. However, decisions on bank bail-outs and other forms of public support for financial institutions will remain in national hands.

What does the industry say?

The European Banking Federation is broadly happy with the proposals. However, it is disappointed that the involvement of the financial services industry "does not appear to have been given much consideration in the new framework, at both the macro and micro levels".

The Committee des European Assurers, the European insurance association, also backs the Commission's measures. "The insurance industry is convinced that supervisory co-operation and convergence is an appropriate answer to the current crisis," says director-general Michaela Koller. However, she calls for the insurance sector to have greater representation on the ESRB.

London, as the EU's main financial centre, has the most to lose from tighter supervision. Angela Knight, chief executive of the British Bankers' Association, says: "What these new European supervisory authorities can and cannot do must be worked out carefully and with attention to the detail".

How much will it cost?

"The cost of attracting adequate and appropriate resources for supervision and oversight of rapidly changing financial and banking markets is a cost well worth incurring when you have regard to the horrifying long-term cost of the alternative", says European commissioner for the internal market and services Charlie McCreevy.

What do the legislators say?

"Better supervision of cross-border financial markets is crucial for ethical and economic reasons," argues Commission president José Manuel Barroso. "The new system will help the EU and its member states to tackle both problems with cross-border firms and the build up of overall systemic risk."

The law of unintended consequences

"It is essential for the EU as well as the UK that this, its largest international financial centre, is not impaired either by insufficient attention being paid to the European process, by accident, or even by prejudice," says Ms Knight.

Could we live without it?

No.

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