Opinion of the European Central Bank of 4 April 2008 at the request of the Finnish Ministry of Finance on a draft government proposal for a law on the Financial and Insurance Supervisory Authority and certain related draft laws (CON/2008/16)

OPINION OF THE EUROPEAN CENTRAL BANK of 4 April 2008 at the request of the Finnish Ministry of Finance on a draft government proposal for a law on the Financial and Insurance Supervisory Authority and certain related draft laws (CON/2008/16) Introduction and legal basis

On 13 February 2008, the European Central Bank (ECB) received a request from the Finnish Ministry of Finance for an opinion on a draft government proposal including a draft law on the Financial and Insurance Supervision Authority (hereinafter, the ‘draft law’), as well as certain other related draft laws . The ECB’s competence to deliver an opinion is based on Article 105(4) of the Treaty establishing the European Community and the third and sixth indents of Article 2(1) of Council Decision 98/415/EC of 29 June 1998 on the consultation of the European Central Bank by national authorities regarding draft legislative provisions , as the proposal concerns Suomen Pankki and contains provisions on rules applicable to financial institutions insofar as they materially influence the stability of financial institutions and markets. In accordance with the first sentence of Article 17.5 of the Rules of Procedure of the European Central Bank, the Governing Council has adopted this opinion.

1. Purpose of the draft law

The purpose of the draft law is to merge the existing Financial Supervision Authority (FSA), which supervises financial markets with the Insurance Supervisory Authority (ISA), which supervises the insurance and pensions industry. The FSA and the ISA will form a new consolidated supervisor under the name ‘Financial and Insurance Supervision Authority’ (FISA) which will begin to operate on

1 January 2009. The FISA will have a similar organisational structure to the FSA, and its powers will largely be a combination of those currently exercised by the FSA and the ISA. The new elements of the FISA’s structure and powers, in particular, relate to the following: (a) The FISA’s objectives and tasks. The FISA’s objective will be ‘to promote the stability of the operations of credit, insurance and pension institutions and other supervised entities, thereby contributing to financial stability and to safeguarding of the interests of the insured, while otherwise maintaining confidence in financial market activity’ . The draft law also contains some tasks that are new or formulated in a more detailed way than the tasks of the FSA and the ISA . In particular, the draft law will include comprehensive provisions in the area of customer protection, combining existing provisions from a number of separate acts . Further, some entities currently supervised by FSA and the ISA will be removed from the scope of the FISA’s supervision . (b) Organisational framework and governance of the FISA. As is the case for the current FSA, the FISA will be established within the organisational structure of Suomen Pankki. The FISA’s governing bodies will be similar to those of the current FSA, namely: (i) the Parliamentary Supervisory Council (which is also one of the governing bodies of Suomen Pankki) ; (ii) the FISA’s Board, which will have powers to decide on the direction of supervisory activity; and (iii) the FISA’s Director General who will exercise most of the direct supervisory powers. The key new elements introduced into the framework are as follows: – as regards the FISA’s Board: (i) the composition of the Board will now include three nominees proposed for appointment by the Suomen Pankki, the Ministry of Finance and the Ministry of Social Affairs and Health, respectively, as well as two members appointed directly by the Parliamentary Supervisory Council ; (ii) any of the Board members will be eligible to be appointed as Board Chairman or Vice-Chairman ; (iii) certain administrative

responsibilities of the Board will be broadened ; and (iv) the Parliamentary Supervisory

Council will decide on Board members’ compensation ;

– as regards the FISA’s Director General: (i) the Director General will be appointed by the

Parliamentary Supervisory Council on a proposal of the Board ; the Director General will

have a fixed term of office of five years ; (ii) the Director General will be entitled to

participate in the FISA’s Board meetings, but not as a voting member as is the case now ;

and (iii) the provisions regarding submission of decisions falling within the scope of the

Director General’s competence for consideration by the Board will be made clearer .

(c) The FISA’s financing: the draft law proposes a funding mechanism aiming at ensuring that 90% of

the FISA’s operational costs are funded by fees collected from the supervised entities, while the

remaining 10% of such costs will be contributed by Suomen Pankki. According to the explanatory

memorandum to the draft law, this Suomen Pankki’s contribution to the FISA’s financing will

ultimately decrease the amounts of profit distributions provided by Suomen Pankki to the State

budget .

(d) Cooperation with other authorities: the FISA’s obligation to disclose information to Suomen

Pankki or to the Government will be broader. In particular, the FISA will be obliged to disclose any

information that may have a significant effect on ‘financial market developments’ . Certain new

detailed administrative and cost-sharing rules will also be introduced in the areas where closer

cooperation with other European Economic Area supervisory authorities is required under the

provisions implementing Capital Requirements Directives .

2. General comment

2.1 The ECB broadly welcomes the general aim of the draft law to strengthen the supervisory structure in Finland, by ensuring that it is appropriately equipped to respond to risks emerging in financial markets, particularly in cross-sectoral domestic activity and in a cross-border context. The ECB has recognised in its previous opinions that the nature and scope of risk in the financial sector is widening, due to closer links between credit institutions, insurance companies, investment firms and pension funds, as demonstrated by the emergence of hybrid financial products, the increased use of risk transfer instruments and the growing role of financial conglomerates . 2.2 Moreover, the ECB notes that, like the FSA, FISA will operate in connection with Suomen Pankki. Indeed, central banks have traditionally been closely involved in the prudential supervision of credit institutions due to their pivotal role in the financial system, in particular regarding the implementation of monetary policy and ensuring the proper functioning of payment systems . Moreover, the maintenance of a close involvement of euro area national central banks (NCBs) in prudential supervision is an important condition for allowing the Eurosystem to contribute adequately to monitoring the risks to financial stability in the euro area , in accordance with Article 105(5) of the Treaty, and to safeguarding smooth coordination between the central banking functions exercised at Eurosystem level and the supervisory functions carried out at national level . 2.3 In this context, the ECB makes a number of comments relating to specific provisions of the draft law, with a view to ensuring the operational independence of the proposed supervisory authority and the appropriate scope of central bank involvement in supervision and oversight policies.

3. Objectives and governance of the supervisory authority

3.1 The ECB broadly welcomes the objectives assigned to the FISA, as well as the clear statement that the FISA will operate in connection with Suomen Pankki . Such cooperation would be particularly important as regards the FISA’s contribution to financial stability, which is also a task performed by Suomen Pankki .

3.2 The ECB notes that the proposals set out in the draft law seek to establish a sound decision-making structure within the FISA. Further to its earlier recommendations , the ECB would like to underline that granting the Director General full membership of the FISA’s Board would enhance the quality of the decision-making process. It should also increase the acceptance and credibility of Board decisions in the market place and the FISA’s commitment to implementing the decisions. 3.3 The ECB welcomes the introduction of a provision providing for a fixed term of office for the FISA’s Director General. It understands that certain general safeguards against dismissal before the lapse of the statutory term in office will apply to the Director General on the basis of Finnish law governing Suomen Pankki staff . The ECB considers nevertheless that appropriate express safeguards should be introduced against unfair dismissal before expiry of the statutory term of office, both in relation to the FISA’s Director General and its Board members. As a minimum, it is recommended to include in the draft law a list of the possible grounds for dismissal of Board members and of the Director General, as well as a clarification regarding the applicable court review procedure. The draft provisions regarding suspension from office should also be reviewed to take into account the issues raised in this paragraph.

4. FISA’s relationship with Suomen Pankki

4.1 Central bank independence safeguards Like the FSA, the FISA will be a body operating in connection with Suomen Pankki. It will form part of Suomen Pankki’s organisational structure, as regulated by the Law on Suomen Pankki and other relevant provisions. As a consequence, all FISA’s acts or omissions will be attributable to Suomen Pankki as the sole legal person liable for such acts or omissions. However, the practical influence of Suomen Pankki’s Board on decisions of the FISA’s Board and Director General will be limited to nomination of one FISA Board member. In the above context, the ECB would like to remind the consulting authority of its views expressed in its previous opinions in circumstances where national laws provide for supervisory authorities to share legal personality with an NCB but be governed by a separate decision-making body, independent from the NCB’s governing bodies responsible for the conduct of core central bank tasks. The ECB has noted in particular that: (i) such a structure, together with the potential exposure of an NCB to liabilities resulting from the supervisory authority’s activity, could be seen as a threat to the NCB’s overall institutional and financial independence ; and (ii) it is important to ensure that decisions adopted by such supervisory authorities do not endanger the finances of the NCB as a whole . The ECB notes that

Suomen Pankki may face risks in relation to the operation of FISA (both as regards its internal management and the adopted supervisory policies and decisions) that will not be limited to its potential financial liability, but may also include, in particular, reputational and operational risks relating to diminished effectiveness of central bank operations, e.g. in the event of disputes arising between the supervised entities and the supervisor. 4.2 Taking the above into account, the institutional framework proposed by the draft law should be reviewed to ensure that Suomen Pankki’s institutional and financial independence will be protected under the proposed reform. In this regard, the ECB’s comments relate to five separate but inter-related dimensions, which will require further consideration individually and in terms of their inter-relationships, with a view to finding a balanced solution. (a) Institutional set-up Some Member States with similar supervisory structures as proposed in the draft law have adopted institutional frameworks which adequately protect their NCBs from risks to their institutional and financial independence. Such frameworks rely, inter alia, on: (i) a sufficiently strong representation of the NCB in the supervisory authority’s governing 32 33 body , which may include the NCB governor acting as ex officio Chair ; or (ii) a duty to obtain the governor’s approval on key supervisory decisions relating to the stability of the financial system . Having regard to central bank independence requirements, the ECB recommends that one of these institutional mechanisms is introduced into the Finnish legal framework . One important safeguard in this respect could be statutory recognition of the current practice of appointing the FISA’s Board member nominated by Suomen Pankki as Chair. (b) Budgetary arrangements FISA’s revenues and expenses will be included in Suomen Pankki’s annual accounts, while the FISA’s Board will be obliged to submit the FISA’s annual budget to the Board of Suomen Pankki for confirmation . The ECB understands that the FISA’s Board is entitled to

independently determine, inter alia, the FISA’s specific objectives and strategic directions, including their budgetary implications, while Suomen Pankki’s powers are limited to returning the FISA’s budget to the FISA’s Board for reconsideration. The ECB recommends that the Board of Suomen Pankki should be given the explicit power to oppose any budgetary proposals submitted by the FISA’s Board and to decide on essential changes to the FISA’s budget if this is necessary in view of the budget’s implications for Suomen Pankki’s independence and its capacity to pursue central banking tasks . (c) The reimbursement mechanism and its financial implications The ECB notes that the draft law provides for a reimbursement mechanism under which the State would ultimately cover any damages paid by Suomen Pankki as a result of errors or omissions in the performance of the FISA’s supervisory tasks, to the extent that such damage exceeds the amount of remaining profit distributable to the State . As stated in the explanatory memorandum to the draft law, the reimbursement mechanism is intended to cater for exceptional situations where Suomen Pankki’s exposure to financial liability resulting from the FISA’s supervisory liability could jeopardise Suomen Pankki’s financial position . The ECB understands from the explanatory memorandum that, under the reimbursement mechanism, Suomen Pankki will in the first place pay the damages to third parties, but ultimately Suomen Pankki will carry the burden of the payment of such damages only up to the amount of profits distributable to the State. If the damages payable by Suomen Pankki exceed the amount of profits distributable to the State, Suomen Pankki (i) will not distribute any profit, as damages have been paid equal to such amount, and (ii) will be reimbursed by the State for the part of the damages paid in excess of the distributable profits ‘without undue delay’. The ECB understands that, due to the nature of this scheme, the reimbursement will not occur until Suomen Pankki’s accounts for the year have been closed and the distributable profit duly determined. Although the ECB welcomes the intention underlying these provisions preventing supervisory liability from being detrimental to Suomen Pankki’s finances as a whole, the ECB remains concerned that the proposed reimbursement mechanism, in the light of the proposed FISA institutional framework , is not sufficient to ensure the NCB’s financial independence. The ECB would therefore suggest giving further consideration to the proposed reimbursement mechanism. One solution would be to ensure that compensation for damage suffered by third parties as a result of errors or omissions in the performance of FISA’s supervisory tasks is paid directly from the State budget. Another possibility, taking into account the function of the reimbursement

mechanism as a measure intended to ensure Suomen Pankki's financial independence, would be to include express provisions in the draft law specifying that expenses relating to the FISA’s supervisory liability will be reimbursed by the State immediately after such expenses have been incurred and presented for repayment by Suomen Pankki. (d) Transfer of ISA’s liabilities and commitments to Suomen Pankki The draft law further provides for a transfer to Suomen Pankki of, inter alia, ‘liabilities and 41 42 commitments’ of the current ISA . In line with its previous opinions , the ECB notes that provisions making an NCB a legal successor to the liabilities of a separate supervisory authority raise issues of compliance with the monetary financing prohibition in Article 101 of the Treaty. The ECB notes that the ISA is currently, unlike the FSA, a legal entity distinct from Suomen Pankki, and that Suomen Pankki will take over the existing liabilities and commitments of the current ISA without being insulated from the financial obligations resulting from the prior activities of such a previously independent public body. This arrangement would be incompatible with Article 101 of the Treaty . The ECB therefore recommends specifying in the draft law that the State will meet any financial obligations incurred by Suomen Pankki as a result of it being substituted for the ISA and that the State should not have any recourse to Suomen Pankki in relation to its liability in this respect . (e) Auditing and reporting regime The draft law is silent with regard to the auditing and reporting regime applicable to FISA. As Suomen Pankki’s annual accounts are audited by independent external auditors under Article 27.1 of the Statute of the European System of Central Banks and of the European Central Bank (hereinafter the ‘ESCB Statute’), the ECB assumes that the auditors’ mandate will be extended to the FISA. However, this point should be clarified expressly in the draft law. 4.3 Central bank role in relation to oversight Article 105(5) of the Treaty assigns the ESCB the task of contributing to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system. The ECB understands that this task is recognised in Section 3 of the Law on Suomen Pankki, which specifies that Suomen Pankki

participates in maintaining the reliability and efficiency of the payment system and overall financial system and participates in their development. 4.4 More specifically, an oversight function is inherent in a central bank’s task of promoting a sound market infrastructure to safeguard the effectiveness of monetary policy and the overall stability of the financial system. As expressed in its earlier opinions, the ECB understands that Section 3, second paragraph, subparagraph 3 of the Law on Suomen Pankki provides the legal basis for Suomen Pankki’s oversight function. The ECB notes that it would be helpful to include an explicit reference in the Law on Suomen Pankki to the oversight function regarding securities clearing and settlement systems and market infrastructure . In the context of the current reform, the ECB recommends that the tasks of Suomen Pankki and the FISA relating to the oversight and supervision of payments and securities clearing and settlement systems and market infrastructure, are specified more explicitly in the legislation, in particular by referring explicitly to Suomen Pankki’s responsibility for oversight of all such systems and infrastructures operating in Finland . 4.5 Exchange of information Under Section 71(5) of the draft law, the FISA will be obliged to disclose, without undue delay, to the Ministry of Finance, the Ministry of Social Affairs and Health and Suomen Pankki any information on ‘matters that, according to the FISA’s judgement, may have significant effect on financial stability or other financial market developments, or cause major disruptions in the operation of the financial system’. The ECB notes that this provision clarifies that the FISA is under a legal obligation to disclose supervisory information to Suomen Pankki. However, extending the disclosure of confidential information to central government administration should not impair the FISA’s operational independence and should comply with Community law. 4.6 As emphasised in previous ECB opinions , central banks provide valuable input to the supervisory process and their access to supervisory information benefits the conduct of monetary policy operations, the oversight of payment systems and the pursuit of financial stability. Transmission of supervisory information and data, primarily in aggregated form, is necessary for effective monitoring of financial stability and for assessing the prevailing conditions in the financial system as a whole as well as for the efficacy of the response when a financial crisis occurs. The ECB would therefore welcome insertion of an explicit provision in the draft law stipulating that FISA has a duty to exchange information with Suomen Pankki in relation to all ESCB-related tasks.

4.7 The ECB recommends that the provisions regarding exchange of information between the FISA and Suomen Pankki and between the FISA and other administrative bodies (domestic or foreign) are combined with express safeguards ensuring the effectiveness of the confidentiality rules applicable to the ESCB, as specified in Article 38 of the ESCB Statute. This opinion will be published on the ECB’s website. Done at Frankfurt am Main, 4 April 2008. [signed]

The President of the ECB

Jean-Claude TRICHET