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Monday, October 11, 2010

The new gatekeeper

For quite some time, we have tried to highlight how the EU's new financial supervisors could eventually take on too much power for comfort - not least when viewed from the City of London. The European Securities and Markets Authority, in particular, looks set to become a force to be reckoned with. As we argued in our recent report on the subject, this is a bit peculiar since most of the commentary - such as the de Larosière report or the Turner review - which precipitated the creation of the new supervisors, related to cross-border supervision of large retail banks.

Over the last couple of weeks, negotiations over the AIFM Directive seem to be moving in the direction of giving ESMA powers, possibly exclusive, to supervise hedge funds and other types of funds based outside the EU and decide whether these should be granted EU-wide market access (a so-called passport). In other words, ESMA could become the sole 'gatekeeper' deciding who has the right to enter the EU market. This is no small power.

The UK could possibly accept such far-reaching powers for ESMA in return for keeping the passport provision in the AIFM Directive - a provision which the French don't like at all but that is popular with the industry.

From the City's point of view, the problem with this arrangement is that market access for the many funds which operate in the City but are domiciled elsewhere (i.e. Cayman or the US) could be decided in a forum where the UK has the exact same voting strength as Malta or Slovakia, as most decisions within ESMA will be taken by simple majority voting, meaning one country, one vote. The lack of safeguards in this voting arrangement could lead to this issue being hijacked by narrow commercial or political interests - or protectionist forces.

A blanket solution to market access, with ESMA calling the shots, would therefore be a mistake. As a leader in today's FT argues,

"Restricting this power to ESMA alone sparks concerns about protectionism. Keeping the state-level door open would also ensure that if ESMA proves inefficient, hedge funds can go directly to national bodies."

Quite right. The negotiations are now entering the final stretch - a break-through could even come today. The UK must resist calls to give ESMA exclusive powers over market access.

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