ESMA: power comes with responsibility

By Klea, Janneke & Elissavet

ESMA stands for European Securities and Markets Agency, located in Paris. This agency forms part of a broader framework of financial supervision known as the European System of Financial Supervision. ESMA’s main task is to ensure stability of the financial markets in the EU, and does this by protecting investors through assessing potential risks. The systemic risk of failure of banks and the overt financial markets are mainly assessed through the Credit Rating Agencies (CRAs) and Trade Repositories (TRs). ESMA has extensive supervisory and enforcement powers to make sure that CRAs and TRs operate in a transparent and fair manner. This extensive granting of powers was seen to be necessary after the financial crisis hit Europe in 2009, where it was found that further integration and supervision of financial markets was needed. Seen as CRAs play a vital role in the decision for investments and were not previously regulated in a strict manner by Member States, ESMA stepped in. The same goes for the importance of TRs. With such extensive powers it becomes ever more so important that matters of legitimacy and accountability are dealt with appropriately. This blog will dive into the judicial accountability of ESMA and how this works out in a recent fine imposed by ESMA to one of the three biggest credit rating agency worldwide.

When it comes to accountability, the good governance principle for which no one seems to be against, even though ESMA is in possession of extensive powers, the discretion is somehow balanced with a well-thought accountability framework. Politically, ESMA is accountable to the European Parliament and the Council, while a number of specific provisions hint towards its accountability towards the Commission.

One of ESMA’s core competences entails drafting the highly detailed technical and implementing standards, a practice which seems to influence the rule-making of the Commission more than usual. This is due to the simple fact that the Commission does not have the adequate resources, the know-how or expertise to control the measures prepared by ESMA (after all this is one of the reasons why the delegation of powers to a highly specialised agency takes place) and at this stage a shift of control happens. As such, it is the agency that controls de facto the Commission, rather than the reverse scenario, possibly entailing long-lasting constitutional consequences.

The process of giving account depends on the types of powers that ESMA is exercising. The most prominent issue is to be found in the case when it exercises its supervisory powers. ESMA is the single supervisor of TRs and CRAs starting from their registration, to their daily monitoring, the investigating in case of doubt and in the end eventual sanctioning. But what about ESMA’s accountability during the process? One disturbing feature is that while in investigation phase, the CRA and EMIR regulations require authorisation from a judicial authority in accordance with national laws, on a setting where in 28 member states, only a few of them require ex ante scrutiny of a national court. And precisely this ex ante scrutiny is believed to be a real accountability check upon the agency. Thus, the dependency on national laws leaves room for differences and asymmetry within the member states, while paving the way to the forum shopping phenomenon.

On July 2016, ESMA imposed a fine of 1 380 000 euro on Fitch Ratings for infringements of the CRA Regulation.

EU legislator had to balance the protection of financial market, actors and Member States of the European Union, with efficiency and the procedural safeguards, namely the rights of the defence. CRA Regulation prescribes what is considered as a good practice for CRAs, what constitutes an infringement and the sanctions imposed. It also defines ESMA as the single and direct supervisor of the CRAs with broad investigative powers. However, there are also limits to the exercise of these powers, since ESMA is obliged to follow a certain procedure where the rights of the defence are of central importance.

The supervision on Fitch Ratings strongly indicated a possible infringement of CRA Regulation which had to be investigated further. The Rating Agency informed Slovenia of downgrading its sovereign debt on 26/01/2012 but not of the grounds for the decision which only did the next day. Slovenia had a 12 hours margin in order to draw the agency’s attention to any possible mistakes, before the decision was published. However, within 3 hours ESMA noticed an unauthorised exchange of emails from Fitch Ratings to a parent company.

An Independent Investigating Officer was appointed and his findings along with the comments of the persons subject in the investigation formed the content of the file, on the basis of which the Board of the Supervisors delivered its decision: Fitch Ratings negligently infringed 3 points of the CRA Regulation; the obligation for 12 hours margin, for internal controls and the provision for unauthorised disclosure. A mitigating factor on behalf of Fitch by taking measures voluntarily in order to prevent future similar infringements was taken under consideration when imposing the fine.

Even though this infringement did not affect the outcome of the ratings according to Fitch Ratings, it still demonstrates the function of ESMA protecting the Member States but at the same time within the prescribed limits of its mandate. Yet, the news was hardly covered by the media, raising questions about the ‘promotion’ of EU positive performance.

ESMA provides an example of an agency for which adequate judicial accountability appears to be in place, as demonstrated by the Fitch Ratings case. Although there are some issues on the accountability front, such as forum shopping, overall ESMA follows the procedures put in place. This is only more important since ESMA is the strongest agency of the EU, and could thus be said to be in a position to set an example.

It appears that the powers that ESMA is able to exercise, for example in terms of supervision and enforcement of CRAs and TRs, are sufficiently counterbalanced by a well-functioning, yet not perfect, accountability framework.