They will also conduct peer reviews of national supervisors and issue recommendations on the basis of the outcomes. In the regulatory area, they will be able to issue non-binding guidelines on the implementation of EU law. The second pillar – macro prudential supervision The second pillar is the establishment of a new European body responsible for macro prudential supervision. The European Systemic Risk Board (ESRB) will be mandated to identify and assess systemic risks on a European-wide basis. Having a common body that provides a “birds-eye view” of financial system risks will help to avoid repeating the mistakes made during the current crisis, where both regulation and supervision focused too much on individual institutions and markets. Also, by looking at risks arising from macro economic trends, as well as from developments within the financial system, the ESRB can identify threats to financial stability coming from both endogenous and exogenous factors. On the basis of its analysis, the ESRB will issue specific risk warnings as well as recommendations for policy action to address the identified risks. These will be directed to those institutions that have the power to take corrective action. This could include memberstate governments or authorities, the European Commission or other EU bodies. Warnings and recommendations will not be binding. Instead they are expected to be followed on a “comply or explain” basis. On a case-by-case basis the ESRB will decide if warnings and recommendations should be disclosed to the public.
I should note that the remaining vulnerabilities in non-bank finance are perhaps the exception, as on the whole the post-crisis reforms have left a financial system that has stood up well to the acute stress of the Covid period. In order to create a framework for reforms, it is important to set out clearly the principles that should shape the changes. The following principles – while not intended as prescriptive rules – are I think helpful in this respect: 1. As a general principle for all funds – investment and money market – redemption terms should be aligned with the underlying liquidity of assets. 2. Where investors regard funds as cash-like, they should be made resilient so they can operate as such at all times, which means running minimal maturity mismatch risk. 3. Money market funds should not hold less liquid assets on a scale that would make them more suitable to be traditional investment funds. 4. Money market funds should not be designed with regulatory thresholds or cliff-edges which create adverse incentives and amplify first-mover advantage behaviour. 5. Reforms should improve the ability of funds to support short-term funding markets, including by making them more resilient. These principles may sound obvious; indeed, I hope they do. But I would emphasise that they are not obvious in the sense that the current landscape is some way from meeting these principles. I think there are three big picture changes which follow from these principles, and should form the basis of the necessary reforms.