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September 2013 - 5 years after the collapse of Lehman:

What the EU has done to learn the lessons from the crisis,

and what still needs to be done

On 15 September 2008, US investment bank Lehman Brothers filed for bankruptcy a watershed in the financial crisis. In the following months, the crisis unfolded spreading to European banks. The European economy fell into recession followed by serious budgetary crises and economic adjustments in several Member States, and a negative spiral between banks and public finances. Five years on, the crisis is not over. But a lot has been done to create the conditions for Europe to grow again. This document highlights what the EU has accomplished since 2008 to put the European financial sector back on its feet and allow it to finance growth once more.

Lehman's collapse highlighted the risk that financial institutions exploit regulatory divergences between different jurisdictions. The ensuing financial crisis was of international scale.

The European Union's response had to be a collective one, firmly anchored in international cooperation.

The EU and its Member States have been instrumental in forging consensus within the G20, involving all major financial centres around the world, on a set of regulatory reforms to strengthen the regulation and supervision of all actors and products within the international financial system. The EU has been faithfully implementing this agenda, the key elements of which were agreed in various summits in 2008 and 2009.

The EU has also taken additional steps necessary to address specific issues within the European financial system, and to ensure the financial system provides the European economy with financial resources necessary to support its path back to growth. [Table listing all measures taken: http://ec.europa.eu/internal_market/publications/docs/financial-reform-for-growth_en.pdf ]

The EU has also adapted its response to respond to the evolving nature of the financial crisis, including the Eurozone debt crisis which highlighted the vicious links between sovereigns and their banks. This has led to the creation of the banking union (http://europa.eu/rapid/press-release_MEMO-13-679_en.htm).

1. First step: a stronger supervision of the European financial sector

The first big step to create the institutional underpinning for closer European cooperation on regulatory and supervisory matters was the creation of the European System of Financial Supervision, including three new European Supervisory Authorities in early 2011 (MEMO/10/434):

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European Banking Authority (EBA) in London for banks1, European Insurance and Occupational Pensions Authority (EIOPA) in Frankfurt for insurance and occupational pensions2, and European Securities and Markets Authority (ESMA)3 in Paris for securities markets as well as a European Systemic Risk Board (ESRB)4 in Frankfurt to monitor financial stability risks.

2. Second step, prevention: Making banks and financial markets stronger to prevent future crises

When Lehman collapsed in 2008, the ensuing deepening of the financial crisis revealed that banks did not have sufficient cushions of capital and liquidity to withstand times of crisis. In 2011, major EU banks were requested to significantly boost their capital. Since then, a full set of new rules requiring banks to hold more and better capital cushions to absorb losses, the so called CRD IV package (http://europa.eu/rapid/press-release_MEMO-13-690_en.htm) with additional requirements for the most important banks to maintain sufficient liquidity to bridge crisis situations, and to limit their leverage (CRD IV/CRR) have entered into force and will gradually apply as of 1 January 2014, making the EU a frontrunner in the implementation of the international Basel III standards. Today, European banks are as capitalised as American banks.

Before the financial crisis, banks' remuneration incentivised excessive risk-taking while their governance was often unsuitable to manage those risks. In order to reduce incentives for excessive risk-taking and ensure banks understand and manage risks properly, bankers' bonuses are now to be capped and banks' risk governance has been strengthened, for example by ensuring independent risk management and compliance functions (also a part of the CRD IV/CRR package).

The downturn in property markets in 2008 and the ensuing losses in complex financial vehicles composed of repackaged mortgages revealed that Investors had relied excessively on credit rating agencies' recommendations which were often too optimistic and not subject to any public supervision. Since 2010, Credit Rating Agencies have been subject to supervision within the EU, and since 2011, this supervision has been directly carried out by ESMA. Further rules addressing remaining conflicts of interest and other concerns were in 2011 and entered into force in June 2013 (http://europa.eu/rapid/press-release_MEMO-13-571_en.htm ). The Commission will also shortly propose high standards to ensure the integrity and supervision for financial benchmarks, such as LIBOR or EURIBOR in order to avoid that those benchmarks are rigged or manipulated to the detriment of consumers and market participants

Derivatives markets were a major channel of contagion following Lehman's bankruptcy quickly spreading uncertainty across financial markets, as they were largely opaque and unregulated. Since early 2013 and in line with G20 commitments, Over-The-Counter (OTC) derivatives markets have been subject to EMiR (http://europa.eu/rapid/press-release_MEMO-12-232_en.htm ), the first comprehensive European market infrastructure regulation requiring to make markets transparent for 1 http://www.eba.europa.eu/

2 https://eiopa.europa.eu/

3 http://www.esma.europa.eu/

4 http://www.esrb.europa.eu/home/html/index.en.html

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supervisors and operators, simplifying markets by obliging standardised OTC derivatives contracts to be cleared on Central Counterparties (CCPs), and establishing comprehensive risk management strategies both for CCPs and for bespoke derivatives. In order to ensure proper regulation of international derivatives markets and avoid duplication, inconsistencies and overlaps which can give rise to international regulatory arbitrage and cross-border uncertainty, the Commission has recently reached an agreement with US regulators to implement EU and US rules in full consistency with each other (MEMO/13/682). The Commission proposal for MiFID in 2011 (IP/11/1219), still under discussion by the co-legislators, will further enhance market transparency for derivatives and other asset classes, in particular by requiring standardised derivatives to be traded only on regulated venues, rather than over the counter between parties.

The financial crisis also showed that non-bank actors, such as hedge funds or money market funds, often provided banking-type services in some cases posing significant risks to financial stability. The European Commission recently made proposals to regulate and supervise actors in the so-called shadow banking sector to ensure that all sources of risk across the financial sector are appropriately dealt with (http://europa.eu/rapid/press-release_IP-13-812_en.htm ). As of 2014, hedge funds and private equity funds in all Member States will also be regulated and supervised to ensure transparency and appropriate risk management and to monitor and address the financial stability risks they pose (http://europa.eu/rapid/press-release_MEMO-10-572_en.htm ).

3. Third step, resolution: Managing financial crises more effectively

Despite stronger supervision and action taken to make the financial sector stronger thus hopefully preventing future financial crises, these may of course still arise and measures have been taken to manage such a crisis more effectively. Indeed, the opening of normal bankruptcy proceedings for Lehman sent major shocks through financial markets. Court proceedings are still ongoing, leaving markets subject to continued uncertainty. Authorities had no appropriate means to resolve banks like Lehman quickly without negative impacts on financial stability. The consequences of Lehmans were such that authorities decided to use taxpayers' money to save other banks to avoid further damage to the economy - banks turned out to be too big to fail.

In order to address these weaknesses, the European Commission proposed new procedures in June 2012 empowering resolution authorities in all Member States to resolve banks quickly without having a negative impact on financial stability, and to coordinate cross-border resolution (http://europa.eu/rapid/press-release_MEMO-13-675_en.htm ). Banks and resolution authorities are required to plan for their possible recovery or resolution in case of failure. In order to avoid the use of taxpayers' money, the Commission proposals enable authorities to require banks' owners and creditors to share the burden of a banks' restructuring, and require Member States to set up resolution funds financed in advance by the banking sector. The Commission proposal should hopefully be agreed in Council and the European Parliament by December 2012. The Commission is also considering options for the most appropriate resolution tools for non-bank market infrastructures (in particular central counterparties).

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In a further effort to address the too-big-to-fail issue, an expert group chaired by the Central bank governor of Finland, Erkki Liikanen, was asked in 2012 to assess whether the planned reforms were sufficient to deal with "too big to fail" and whether additional reforms addressing banks' structure were necessary. Based on the group's recommendations (IP/12/1048), the Commission will make appropriate proposals to address any outstanding issues in November 2013.

4. Restoring trust in the financial sector: enhancing consumer protection

Lehman's bankruptcy hit thousands of retail clients around Europe, who had been sold investments which were much more risky than they thought. In the ensuing financial crisis, many more customers turned out to have taken excessive risks due to insufficient information, poor advice, or fraudulent practices on derivatives, bank debt or investment funds. When banks failed, cross-border deposit-holders did not always receive full compensation from deposit guarantee schemes. As a result, many citizens have lost confidence in banks and the financial system at large.

In order to restore lost trust and to create a safe environment for cross-border financial services within the single market, the Commission proposed new rules to ensure retail customers receive full information in understandable terms, proper advice, and advisors act in the best interest of clients (IP/12/736).

In order to ensure investment funds are managed in the interest of investors, the Commission also proposed safer rules for retail investment funds (UCITS http://europa.eu/rapid/press-release_MEMO-12-515_en.htm ).

The Commission has also proposed strengthening national deposit guarantee schemes in order to strengthen them and ensure depositors have full access to their money in case of a bank crisis (IP/10/918), and proposed similar rules for investor compensation (IP/10/918).

Finally, the Commission has made proposals make bank accounts cheaper, more transparent and accessible to all (http://europa.eu/rapid/press-release_IP-13-415_en.htm).

5. Creating a banking union to break the link between the strengthen the Euro

In addition to the regulatory and supervisory framework applicable in the whole EU, the shared responsibilities and cross-border links within the euro area require specific measures to sustain confidence in the single currency. In particular, a banking union is necessary to break the harmful connections between sovereign debt markets and banks. This deeper integration, compulsory for the euro area, and open to all Member States, will build on the single rule book of prudential requirements, crisis prevention, management and resolution and deposit guarantees for all banks in the EU [ http://europa.eu/rapid/press-release_MEMO-13-679_en.htm ].

In September 2012, the Commission proposed that responsibility for banking supervision will move from the national to the European level through a Single Supervisory Mechanism, under the European Central Bank (IP/12/953). The structure will ensure strict and objective supervision across

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participating Member States and allow for efficient supervision of cross-border banking activities. The single supervisor is therefore key to breaking the link between sovereign and banking risks.

In July 2013, the Commission also proposed a Single Resolution Mechanism to complement the Single Supervisory Mechanism (SSM) and ensure that not withstanding stronger supervision - if a bank subject to the SSM faced serious difficulties, its resolution could be managed efficiently with minimal costs to taxpayers and the real economy. The Single Resolution Mechanism would consist of a Single Resolution Board and a Single Bank Resolution Fund (IP/13/674).

Creating a banking union is an essential part of the Commissions efforts towards a deeper economic and monetary union. In addition to an integrated financial framework, the other building blocks are integrated budgetary and economic policy frameworks, and further improvements to the EUs democratic accountability.

6. Supporting the growth-enhancing functions of financial markets

In the past five years s, Europe's economy has seen a serious recession, which despite some recent more positive signs, is not over. The financial crisis has affected the ability of the financial sector in Europe to channel savings to investment needs. Above all, the financial crisis and the current weak macroeconomic situation have created a climate of uncertainty and risk aversion, particularly in those Member States under financial pressure and for SMEs. The financial crisis has impaired banks' ability to lend at long maturities, as they need to deleverage correcting the excesses of the past. At the same time, the crisis has had a negative impact on the confidence and risk appetite of borrowers and institutional investors.

By putting Europe's financial sector on a more resilient basis and overcoming market fragmentation, the EU initiatives above will contribute to ensure the financial sector can also deliver financing for growth. In addition, the Commission has made several proposals specifically targeted at unlocking the single market's growth potentials by removing barriers.

Cross-border business will be facilitated by a Single Euro Payments Area5 [http://europa.eu/rapid/press-release_MEMO-11-936_en.htm ] which will be created by 1 February 2014, and by proposed rules for innovative payments services & the interbank fees paid on card transactions (IP/13/730).

As a complement to the reforms of the European banking sector, the Commission has also made proposals to facilitate alternative sources of venture capital, social entrepreneurship and long-term finance (IP/11/1513).

Taken together, these measures offer a comprehensive response to the crisis which kicked off with Lehmans collapse 5 years ago. Europe is both learning the lessons from that crisis and putting place measures so mistakes are not repeated, and creating a stronger financial sector at the service of the real economy and growth. 5 http://ec.europa.eu/internal_market/payments/sepa/