Financial regulators play a crucial role in monitoring and regulating financial markets. They help to maintain public confidence in the financial system and ensure the stability of financial markets.

In this paper, we will take an in-depth look at the role of financial supervisors, explaining their various functions and tasks, examining the legal basis for their activities and discussing recent examples and court rulings that affect their work.

Table of contents

  1. Purpose and function of financial regulators
  2. National and international financial regulators
  3. Legal basis of financial supervision
  4. Tasks and responsibilities of financial regulators
  5. Examples of the work of financial regulators
  6. Recent court decisions and their impact
  7. How important are financial regulators really?

Purpose and function of financial regulators

Financial supervisors are tasked with ensuring the integrity and stability of financial markets and maintaining public confidence in the financial system. To achieve this, they supervise the activities of financial institutions, such as banks, insurance companies and investment firms, to ensure that they comply with applicable laws, regulations and best practices.

The functions of financial supervisors can be divided into different areas:

Preventivemeasures: Financial supervisors use preventive measures to identify and minimise potential risks to the stability of financial markets at an early stage. This includes reviewing business models, internal control systems and risk management practices of financial institutions. Examples of preventive measures are:

  • The introduction of capital and liquidity requirements for banks, such as Basel III or the Capital Requirements Directive (CRD IV), which ensure that banks have sufficient financial reserves to withstand economic shocks.
  • The introduction of rules of conduct for financial service providers, such as the Markets in Financial Instruments Directive (MiFID II), which are intended to strengthen consumer protection and prevent abusive market practices.

Repressive measures: Financial supervisory authorities take repressive measures to detect and punish violations of financial market regulation. These include investigations, sanctions and, where appropriate, cooperation with law enforcement agencies. Examples of repressive measures are:

  • Imposing fines or administrative penalties on financial institutions that violate regulations, such as in the case of banks involved in the manipulation of reference interest rates such as LIBOR.
  • The enforcement of trading bans or disciplinary measures against individuals guilty of insider trading or other market manipulation.

Regulatory cooperation: Financial regulators cooperate at the national and international level to effectively regulate cross-border financial services and reduce the risk of regulatory arbitrage. Examples of supervisory cooperation are:

  • The exchange of information and coordination of actions between national financial supervisors, as in the case of the European Supervisory System, which consists of the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA).
  • Participation in international organisations and standard-setting bodies, such as the Financial Stability Board (FSB) or the International Organisation of Securities Commissions (IOSCO), to harmonise global financial market regulation and develop common standards.

A recent court decision highlighting the role of financial regulators is the ruling of the Federal Administrative Court in Germany on 19 March 2019 (case no. 8 C 6.18). In this case, the court found that BaFin was entitled to order a bank to cease certain business relationships and ensure the implementation of adequate control mechanisms due to insufficient anti-money laundering measures.

This ruling underlines the importance of financial supervisory authorities in enforcing compliance requirements and combating financial crime.

National and international financial regulators

Financial supervisory authorities operate at various levels to ensure the stability and integrity of financial markets. In this section, we will take a closer look at the various national and international financial supervisory authorities, explain their responsibilities and tasks, and present some examples from practice as well as relevant laws and recent court rulings.

National financial supervisory authorities

Federal Financial Supervisory Authority (BaFin) in Germany: BaFin is the central financial supervisory authority in Germany and is responsible for the supervision of banks, insurance companies, securities service companies and financial services institutions. Its main tasks are the examination and approval of business models, the monitoring of compliance with laws and regulations as well as the investigation of violations and the imposition of sanctions.

The legal foundations for BaFin’s work include the Financial Services Supervision Act (FinDAG), the German Banking Act (KWG) and the Securities Trading Act (WpHG).

Financial Conduct Authority (FCA) in the UK: The FCA is the UK financial regulator responsible for regulating and supervising the financial services industry. Its main tasks include ensuring market integrity, promoting competition and consumer protection, and preventing financial crime. The FCA is governed by the UK Financial Services and Markets Act 2000 (FSMA) and the rules and regulations contained therein.

Securities and Exchange Commission (SEC) in the US: The SEC is the US financial regulatory agency responsible for overseeing and regulating the securities markets and their participants. Its main tasks are to maintain market integrity, prevent market abuse and promote transparency and disclosure. The legal basis for the SEC’s work includes the Securities Act of 1933 and the Securities Exchange Act of 1934.

International Financial Regulators:

European Central Bank (ECB): the ECB is the central bank of the euro area and is responsible for conducting monetary policy and supervising the banking sector in the member states. Under the Single Supervisory Mechanism (SSM), the ECB has direct supervision over significant banks in the euro area and works closely with the national financial supervisors of the member states.

The legal basis for the ECB’s work is the Treaties on European Union (EU Treaties) and the Statute of the European System of Central Banks and of the European Central Bank.

European Banking Authority (EBA): The EBA is an EU agency responsible for promoting the convergence of financial supervisory standards in the EU and developing guidelines and technical standards for banking regulation. It supports cooperation and coordination between national financial supervisors and contributes to the development of the single rulebook for banking supervision in the EU.

The legal basis for the EBA’s work is EU Regulation No 1093/2010 and EU directives and regulations in the field of banking regulation.

International Organisation of Securities Commissions (IOSCO): IOSCO is an international organisation that promotes cooperation and standardisation among securities regulators worldwide. It develops guidelines, standards and principles for securities regulation and supports the exchange of information and cooperation among its members.

IOSCO has no legal powers, but its recommendations and standards can be adopted voluntarily by national and international financial regulators.

Recent court rulings

A relevant recent court ruling is the European Court of Justice (ECJ) decision in Case C-577/18, which clarifies the competences of national financial supervisory authorities in relation to the cross-border activities of investment firms.

The ECJ has ruled that the securities supervisors of the home Member State are competent to supervise the compliance of investment firms with MiFID II rules, even if they provide cross-border services in other Member States.

This decision has important implications for cooperation between national financial supervisors and the regulation of cross-border financial services in the EU.

Legal basis of financial supervision

Financial supervision is based on a variety of laws and regulations that apply both nationally and internationally. In this section, we will explain some of the most important legal foundations of financial supervision in more detail.

National laws

In Germany, the Federal Financial Supervisory Authority (BaFin) is regulated by a number of laws and regulations. Some of the most important laws are:

1. Financial Services Supervision Act (FinDAG): The FinDAG establishes the legal framework for BaFin’s activities and regulates its responsibilities, tasks and powers. It also contains provisions on cooperation with other national and international financial supervisory authorities and on the enforcement of financial market regulations.

2. German Banking Act (KWG): The KWG is the central law regulating the banking sector in Germany. It contains provisions on the granting of banking licences, capital adequacy, liquidity monitoring and banking supervision.

3. Securities Trading Act (WpHG): The WpHG regulates trading in securities and the activities of securities services companies in Germany. It contains provisions on market transparency, the prevention of insider trading and market manipulation, and the monitoring and enforcement of securities trading regulations.

European laws and directives

At the European level, there are numerous regulations and directives that affect financial supervision. Some of the most important are:

1. Markets in Financial Instruments Directive (MiFID II): MiFID II is a comprehensive directive that harmonises the regulation of financial markets and financial services in the European Union. It sets requirements for the organisation and conduct of financial services institutions and includes rules on transparency, best execution and investor protection.

2. Bank Resolution Directive (BRRD): The BRRD sets common rules for the resolution of banks in the EU to minimise the risk of banking crises and their impact on financial stability. It contains provisions on early intervention, planning of resolution plans and the creation of resolution funds.

3. Capital Requirements Directive (CRD IV) and Capital Requirements Regulation (CRR): The CRD IV and CRR provide the common legal framework for the supervision of banks in the EU and set requirements for capital adequacy, liquidity standards and leverage ratios. They are based on the international standards of the Basel Committee on Banking Supervision (Basel III).

Recent court rulings

Court rulings can have important effects on the legal foundations of financial supervision. One example is the ruling of the European Court of Justice (ECJ) in the Landeskreditbank Baden-Württemberg case (Case C-450/15), in which the ECJ ruled that BaFin does not have the power to order a bank to change certain business practices regarding the adjustment of interest rates on variable-rate loan agreements, as this falls within the competence of national civil courts.

Another example is the ruling of the Federal Court of Justice (BGH) in Germany in the Commerzbank AG case (ref. XI ZR 33/17), in which the BGH ruled that when granting loans to finance corporate takeovers (so-called leveraged buyouts), banks must inform their customers about the risks of the financing and the possible conflicts of interest in order to fulfil their regulatory obligations.

These rulings show that the legal basis of financial supervision is dynamic and can be further developed and specified by case law. Financial supervisors must therefore always keep up to date and adapt their practices to current legal developments.

Tasks and responsibilities of financial regulators

The tasks and responsibilities of financial supervisory authorities cover a wide range of activities aimed at ensuring the stability and integrity of financial markets and maintaining consumer confidence in the financial system. The following provides a detailed insight into the various areas of responsibility and legal foundations that shape the work of financial supervisory authorities.

Review and approval of business models and practices of financial institutions

Financial supervisory authorities are responsible for reviewing and approving business models and practices of financial institutions. This includes reviewing the institutions’ compliance systems, risk management structures and internal control procedures.

Legal bases for this task are, for example, the German Banking Act (KWG), the German Insurance Supervision Act (VAG) and the German Securities Trading Act (WpHG). These laws require, among other things, that financial institutions have sufficient equity to cover potential losses and that they implement appropriate business and risk management processes.

Monitoring financial institutions’ compliance with laws, regulations and best practices

Financial regulators are responsible for monitoring financial institutions’ compliance with laws, regulations and best practices. They conduct regular examinations and inspections to ensure that institutions comply with their legal obligations.

The legal basis for this task includes the German Banking Act (KWG), the German Insurance Supervision Act (VAG), the German Securities Trading Act (WpHG) and the German Solvency Regulation (SolvV). Within the scope of these supervisory activities, for example, compliance with capital requirements, the proper handling of customer transactions or the implementation of anti-money laundering measures are reviewed.

Investigation and sanctioning of violations of financial market regulation

Financial supervisory authorities have the power to investigate and sanction breaches of financial market regulation. This may include, for example, imposing fines, ordering measures to restore compliance or revoking licences.

Legal foundations for this task can be found in the German Banking Act (KWG), the German Insurance Supervision Act (VAG), the German Securities Trading Act (WpHG) and the German Banking Act (KWG), among others. A court ruling in this context is the “Cum-Ex” case, in which the Federal Supreme Court (BGH) affirmed the liability of banks for participating in fraudulent share transactions (ruling of 29 March 2021, ref. GSSt 2/20).

Development of guidelines and recommendations to improve financial market regulation

The financial supervisory authorities develop guidelines and recommendations to improve financial market regulation. These guidelines may relate to various aspects of regulation, such as combating money laundering, managing systemic risk or improving transparency and disclosure of financial information.

One example is the development of guidelines and technical standards by the European Banking Authority (EBA) as part of the implementation of the revised Payment Services Directive (PSD2).

Cooperation with other national and international financial supervisory authorities

Cooperation between national and international financial supervisors is an essential component of effective financial market regulation. This may include, for example, the exchange of information and best practices, the coordination of investigations and the development of common standards and guidelines.

One example is the cooperation between BaFin and the European Central Bank (ECB) under the Single Supervisory Mechanism (SSM), which ensures the joint supervision of significant banks in the euro area.

Thus, the multiple tasks and responsibilities of financial supervisors help to ensure the stability and integrity of financial markets and maintain consumer confidence in the financial system. The work of financial supervisory authorities is based on a variety of legal foundations and is informed by numerous examples and recent court rulings that underline their importance and relevance in today’s globalised financial world.

Examples of the work of financial regulators

The work of financial supervisory authorities is diverse and covers many aspects of financial market regulation. In the following, we will examine some concrete examples of the work of financial supervisory authorities, including their legal basis and the impact of their activities on the financial sector.

Combating money laundering and terrorist financing: Financial supervisory authorities play a crucial role in combating money laundering and terrorist financing. They monitor financial institutions’ compliance with anti-money laundering (AML) and know-your-customer (KYC) regulations and enforce sanctions against companies and individuals that violate these regulations.

Regulation of FinTech companies: The increasing digitalisation of the financial sector has led to a rise in FinTech companies offering innovative financial services. Financial regulators need to ensure that these companies comply with applicable laws and regulations to ensure consumer protection and financial market stability.

Protection of retail investors: Financial supervisors are responsible for ensuring the protection of retail investors by monitoring compliance with rules on investment advice and intermediation and imposing sanctions on companies and individuals that breach these rules.

Control of bank mergers and acquisitions: Financial supervisors are also responsible for monitoring bank mergers and acquisitions to ensure that they are carried out in accordance with applicable laws and regulations and do not have a negative impact on financial stability.

Overall, these examples show how diverse and complex the work of financial supervisors is and how important their activities are for regulating financial markets and protecting consumers. By monitoring compliance with laws and regulations and enforcing sanctions against companies and individuals that violate these regulations, financial supervisory authorities play a significant role in maintaining the integrity and stability of financial markets.

Recent court rulings and their impact

The work of financial supervisory authorities and their decisions are regularly reviewed by courts and, if necessary, corrected or confirmed. In the following, some interesting court decisions and their impact on the work of financial supervisory authorities are examined in more detail.

ECJ judgment on cross-border financial services supervision (Case C-66/19)

  • In Case C-66/19, the European Court of Justice (ECJ) ruled in 2020 that the competences of national financial supervisory authorities in regulating cross-border financial services are not unlimited.

The ECJ held that while national authorities have the right to supervise and, where appropriate, impose sanctions on foreign financial service providers operating on their territory, this is only under certain conditions and in line with the principle of free movement of services within the EU.

This decision has important implications for cooperation between national and international financial supervisors and ensures that the European single market for financial services is not hampered by disproportionate interference by national authorities.

  • Federal Supreme Court (BGH) and the supervisory duty of financial institutions (ruling of 25 June 2019, ref. XI ZR 768/17)

In this judgment, the BGH ruled that financial institutions have a special duty of supervision towards investors when brokering capital investments. This includes, among other things, the duty to inform customers about possible risks and to ensure that the financial products offered are suitable for the respective customer. In the specific case, a credit institution had violated these duties and was therefore ordered to pay damages.

This ruling underlines the importance of the supervisory duty of financial institutions and shows that the financial supervisory authorities also play an important role in this area by monitoring compliance with these duties and imposing sanctions in the event of violations.

  • ECJ Judgment on Investment Advice and MiFID II (Case C-542/18)

In Case C-542/18, the ECJ clarified in 2020 that the MiFID II Directive’s rules on investment advice are directly applicable in all EU Member States and that national courts are obliged to take these rules into account when assessing disputes between investors and financial service providers. The specific case concerned the question of whether a financial service provider had breached its duties to provide information and advice.

This judgment emphasises the importance of European financial market regulation and the need for financial supervisory authorities to ensure compliance with MiFID II rules by the financial institutions they regulate.

In summary, the aforementioned court rulings show that the work of financial supervisory authorities is of great importance and is subject to legal requirements set at both national and European level. The judgments also illustrate that financial supervisors play a crucial role in protecting the interests of investors and ensuring the stability of financial markets.

How important are financial regulators really?

In conclusion, the role of financial supervisors is crucial in ensuring the stability and integrity of financial markets. Their work, which ranges from supervising and regulating financial institutions to investigating and punishing violations, is based on a variety of legal foundations and is informed by numerous examples and recent court rulings.

It is important that financial supervisors continue their efforts to maintain public confidence in the financial system and protect financial markets from potential risks and abuses.