If EU regulation and internationally agreed standards diverge materially, it will both create barriers to that activity and opportunities for regulatory arbitrage making it more difficult to ensure UK financial stability. My third example is the European Supervisory Authorities – the European Banking Authority (EBA), European Securities and Markets Authority (ESMA) and European Insurance and Occupational Pensions Authority (EIOPA). These were established to provide more detailed common rule making so that the EU Single Market in financial services could be supported by a common rule-book underneath the framework of high-level legislation. This search for more detailed alignment of regulation and standards has I think been a general feature of the post crisis reforms in the EU and more widely. The ESAs are governed by their boards, comprising national supervisory authorities, which are also responsible for the majority of their financing. They set and advise the Commission on the rules and standards – they do not engage directly in the prudential supervision of firms. The European Supervisory Authorities perform another important function. I have talked about common rules, commonly applied. There are of course enforcement mechanisms in the Treaties to ensure member States properly observe the EU legislation. But the need for this in financial services has been especially recognised with the ESAs having the capability to conduct peer reviews and for binding arbitration when one national authority believes another has not properly implemented or applied the rules. This is a powerful mechanism to prevent regulatory arbitrage and the risk of adverse spillovers between member states.
It was not fully completed until the Maastricht Treaty of 1992 when free movement of capital became a directly applicable Treaty right. And throughout this process, in recognition of the potentially destablising effect, safeguards were included to allow member states to defend their stability, including in relation to prudential supervision. The real push for free movement of capital came in the mid 80’s when European growth was sluggish, especially compared to the US and Japan. There was a search for policies to generate economic dynamism, which led to the birth of the single market. But, of course, until capital could flow freely between member states it was not really possible to have a single market in financial services or, in the financial sector, to give effect to that other founding freedom – the freedom to provide services across the EU. The liberalisation of capital markets in the EU was rooted in two beliefs. First and foremost that open capital markets, cross border investment and cross border financial services would create a more efficient allocation of capital through better intermediation between savers and borrowers across the EU as a whole. And, second, that the risks to economic and financial stability of an open capital account and cross border financial services could be managed by sound economic and financial policies to prevent destabilising volatility of capital flows and by good financial services regulation at the EU level.