FACTBOX-De Larosiere report on EU financial market supervision

25 Feb (Reuters) - A high-level group headed by former IMF Managing Director and ex-Bank of France Governor Jacques de Larosiere recommended on Wednesday reform of cross-border financial supervision in the EU to remedy flaws in the bloc's patchwork of national based supervision.

Faced with member state fears of losing local regulatory sovereignty, the report suggests changes should be phased in over four years and stops short of introducing an all-powerful, pan-EU regulator, according to a draft obtained by Reuters.

The report offers a two-level approach to reform -- new oversight of broad, system-wide risks and a beefing-up of coordination among national supervisors in day-to-day oversight. Both would closely linked. For story click on [ID:nLP384492]

The report's main recommendations are:

MARKET-WIDE SUPERVISION OF RISK

-- Setting up a "European Systemic Risk Council" (ESRC) to be chaired by the European Central Bank president. It would be composed of members of the general council of ECB, a member of the European Commission and chairs of the three existing pan-EU committees of banking, insurance and securities supervisors.

-- Establishing an effective risk warning system under the auspices of the ESRC and the existing Economic and Financial Committee, which is made up of national treasury officials. If the ESRC thinks a local supervisor is taking inadequate action to deal with risk, it could take further action.

-- Making improvements in how a banking crisis is handled. For example, EU states should agree a more detailed criteria for burden sharing or who bails out a failed cross-border bank.

DAY-TO-DAY SUPERVISION

-- Creating a European System of Financial Supervisors and a decentralised network, with existing national supervisors continuing to carry out day to day supervision.

Three new European authorities would be set up to replace the existing three pan-EU committees of banking, insurance and securities supervisors known as CEBS, CEIOPS and CESR. Colleges of supervisors would be set up for all major cross-border insitutions.

The ESFS would be independent of political authorities but be accountable to them. It should rely on a common set of core harmonised rules.

REFORMING INSTITUTIONS

-- A fundamental review is needed for the globally-agreed Basel II rules on capital requirements for banks, such as stricter rules for off balance sheet items.

-- A common EU definition of regulatory capital should be adopted.

-- National supervisors should collectively be responsible for registering and supervising credit rating agencies.

-- A wider reflection needed on mark-to-market accounting standards, blamed by some for exacerbating the impact of the credit crunch on banks. The oversight and governance of the International Accounting Standards Board, which sets accounting standards used in the EU, should be strengthened.

-- Draft EU insurance industry rules known as Solvency II must be adopted and include a binding mediation process between supervisors and the setting up of harmonised insurance guarantee schemes.

-- Regulation should be extended to the so-called parallel banking system, and there should be registration and information requirements on all major hedge funds. There should be capital requirements on banks owning or operating a hedge fund or engaged in significant activity with a hedge fund. -- Supervisors should oversee the suitability of compensation policies at financial institutions. (Reporting by Huw Jones, editing by Mark John and Toby Chopra)