The legal impact of non-binding regulatory acts

Financial regulation in the EU is more and more driven by non-binding acts of authorities like ESMA. The impact of non-binding regulatory acts, however, goes beyond the original remit of these documents. The German regulator BaFin has now confirmed what we all already knew: These acts are far from mere recommendations. Instead there are likely to be legal consequences for non-compliance. Which is why it is all the more important that your regulatory change management is up to the task.

You may remember the good old days when laws where issued in a single document and everything was clear from the start. Or so it seemed. Nowadays financial regulation often comes in the form of dozens of documents – a directive in combination with one or more regulations supplemented by regulatory and implementing technical standards (“RTS” & “ITS”). On top of that there are guidelines and Q&A documents issued by ESMA, EBA and EIOPA and, of course, that is only the EU level, because in many cases there is also the national level at the member states that transpose EU rules into country law. Take MiFID II with its endless list of RTS, ITS, Guidelines, Opinions, and Q&As. Of the latter, ESMA alone lists eleven on its website.

The man responsible for this structure is Baron Alexandre Lamfalussy, a Hungarian-born Belgian economist and central banker. He was after the chair of the EU advisory committee that created the Lamfalussy Process. It refers to a process to come up with better and more efficient financial service industry regulations that was originally developed in March 2001 by the European Union. This process is composed of four “levels,” each focusing on a specific stage of the implementation of legislation. In principle, the Lamfalussy Process aims to provide several benefits over traditional lawmaking, including more-consistent interpretation, convergence in national supervisory practices, and a general boost in the quality of legislation on financial services.

With the creation of the EU supervisory authorities, i.e. ESMA, EBA and EIOPA, the process has been amended to award these specialist authorities greater involvement and powers. In the regulations establishing each authority was awarded special powers, for instance for ESMA in the ESMA Regulation No 1095/2010 that sets out the tasks and powers of each of the three. A law like MiFID II was impossible to be designed in simply one legislative document as the level of detail that is required to address all aspects of the legislative framework could only be delivered through the work of specialised authorities together with the input of the financial industry itself.

The EU, however, has already been blamed on many occasions for being a construct that lacks democratically valid legislative processes and the fact that elected lawmakers, i.e. the members of the European Parliament, would contribute only partially could be seen in the same context, especially if the acts of an institution like ESMA would de facto issue binding rules that are on the same legislative level as laws. The reality on the other hand makes this approach necessary though as outlined above on the example of MiFID II.

A statement by the German financial regulator now confirms this as the BaFin highlights that it would continue to adopt Opinions, Guidelines and Q&As in its supervisory activities unless it would create a conflict with existing German regulation. While that is in line with EU law, in practice it appears to be less of an issue as BaFin pointed out that out of the 180 guidelines and 3,000 Q&As that have been published the vast majority has been adopted. What happens though if there is a conflict of the kind of relevance that would make the authorities clash is something to decide for the European courts. BaFin emphasis that the practice of adoption happens in line with the comply-or-explain-process as a simple „comply“ declaration addressed at the respective authority, which for Q&As might not even be necessary.

It is in any case an interesting admission of a national regulator given that such acts are not legally binding. In is in line with the practice of other regulators of member states, but in particular with regard to the Brexit negotiations and transpositions should provide for an interesting discussion for the Bank of England and the FCA. In practical terms it means for a financial institution that the regulatory change management is up to the task and needs to cover all potentially relevant authorities as ignorance or the notion that the original act was not legally binding will not be enough.