Review: ‘Financial Market Regulation: A ‘Lamfalussy Exit’ from the Joint-Decision Trap’ by Zdenek Kudrna (Chapter 5 from The EU’s Decision Traps: Comparing Policies, 2011).
In ‘Financial Market Regulation: A ‘Lamfalussy Exit’ from the Joint-Decision Trap’, Zdenek Kudrna, a political economist at the University of Salzburg, assesses the success of implementing technocratic measures in EU comitology. Kudrna argues that the capacity of the Lamfalussy process (2001) in the realm of EU financial market regulation has greatly facilitated the policy-making process due to ‘complex, yet consistently enforceable, technical compromises’. By comparatively assessing the Market in Financial Instruments Directive (MiFID), which is being adopted using the legislative approach of the Lamfalussy Process, and the key weaknesses of the MiFID’s predecessor, the Investment Services Directive (ISD), Kudrna argues that delegating power to technocratic committees can curb the phenomenon of the ‘lowest common denominator’ policy being chosen and, in this way, provides a new exit from the joint-decision trap (JDT) in financial markets.
I. THE JOINT-DECISION TRAP: AN EMPIRICAL PUZZLE
Since the publication of Scharpf’s seminal argument (1988), decision-making within the European Union has often been argued to present a joint-decision trap. This trap consists of national actors who possess the ability to block agreements unilaterally, therefore producing decision making by the lowest common denominator. The presumption that it is sufficient to eliminate barriers for cross-border trade and harmonise product standards for markets to integrate seamlessly worked relatively well for the single market of goods. However, this proved insufficient for regulated markets in financial services, where ‘the enforcement of common standards inevitably provides considerable discretion to regulatory and supervisory authorities’ (Kudrna, 2016). Thus, so long as enforcement remains decentralised within national supervisors, market fragmentation arises from differences in how each authority exercises its discretionary powers. In the text, Kudrna acknowledges this empirical puzzle, stating that a key challenge for the EU financial regulation policy is how to overcome the deeply divergent preferences of the member states, despite agreement on a bulk of regulatory measures. He argues that this dilemma has led to a tendency amongst the member states to cluster into two coalitions (‘North-South divide’) when it comes to security regulation; the latter supporting protectionist regulation and the former pro-competition regulation. As a result, the lowest common denominator has often been chosen and the joint-decision trap has remained alive and well. The EU has clearly implemented several directives and decision-making procedures over the past three decades to tackle this issue, however it is unclear whether these reforms have legitimately provided new exits from the joint-decision trap. Kudrna’s article specifically addresses this issue as the main research question and provides an optimistic outlook on the future of EU financial market regulation by stating that the Lamfalussy procedure has indeed succeeded in facilitating decision-making processes.
II. POSITION WITHIN THE ACADEMIC DEBATE
The publication of Schwarf’s joint decision trap argument in 1988 led to several academics pointing the finger at different phenomena in an attempt to disprove the authenticity of the seemingly pessimistic decision-making mechanism. Kudrna, Holzinger (2011) and Peters (1997) are only a few examples of arguments that demonstrate how joint-decision traps can be avoided in certain domains of EU policy-making. Antithetically, certain academics take it upon themselves to show how Schwarf’s joint decision trap is still alive and well (Auel, 2008) in contemporary EU policy-making. Apart from Kudrna’s argument clearly belonging within this school of discourse on the salience of the JDT in EU policy-making, his insistence on technocratic committees as a means of facilitating progression is inherently tied into the discourse of the place of technocracy within EU institutions. This has undoubtedly become a popular topic of debate, with some condemning delegation to technocrats as an extreme hazard to contemporary democracy. Marquardt (1994), for example, argues that technocracy is inherently a threat to democracy and should be seen as detrimental to EU accountability and legitimacy. Moravcsik (2002) and Majone (1998) on the other hand, have advocated for an ‘enlightened technocracy,’ denying the EU suffers from a ‘democratic deficit’. Kudrna’s argument therefore provides a pro-technocrat argument concerning financial markets, showing how delegating policy-making power to technocrats facilitated European financial market regulation and curbed the JDT.
III. EMPIRICAL DATA
A majority of the evidence Kudrna provides in supporting his argument comes from his comparative analysis of the ISD and the MiFID, the latter being adopted through the Lamfalussy process. He begins by quantitatively depicting the structural diversity of financial sectors in Europe in 2005 through table 5.1, which shows how certain countries rely more heavily on bonds, equity markets whilst others rely on bank financing, reinforcing how these differences perpetuate the JDT in financial market regulation. He then groups all European countries into the two coalitions, the liberal North and the protectionist South, in order to conceptualise a pay-off matrix between these two coalitions in the securities regulation market. This shows how the JDT would predict the status quo, where Northern states stick with their pro-competition model and the Southern states stick to their pro-protectionist model.
In order to demonstrate how the ISD resulted in the status quo (or the lowest-common denominator) policy decision to be undertaken, whilst the MiFID allowed for a Nash equilibria, Kudrna examines in detail the ISD and the MiFID and their procedures. In Table 5.3, he outlines the differences in the levels of two different decision-making processes. He argues that replacing the unanimity procedure in the Council by introducing qualified majority voting in 1987 was not sufficient in providing an exit from the joint-decision trap, as both the MiFID and the ISD boasted majority-voting – however, Lamfalussy allowed the MiFID to take full advantage of qualified majority voting. He then analyses the ISD and two of its controversies which he argued were caused by diverging preferences between member states: the conduct of business rules, which protect consumers from unfair business practice, and the permissible degree of competition among stock exchanges across the EU. His evidence for the former is exemplified by the final provision of Article 11 of the ISD, which represented a compromise in favour of mutual recognition and the precise legal wording of rules were left to the member states, leaving the member states free to add their own regulation. Furthermore, the lengthy process of attempting to agree on the ISD also shows how the JDT occurred within these negotiations.
Kudrna also points out that even after The Commission tabled a new ISD proposal to make it more palatable for EU MS, conflict on the parameters of regulated markets rule lasted over two years which were marred with conflict between key member states, leading to the ISD almost being scrapped all together. The ISD was approved in May 1993, five months after the single market deadline. Kudrna then concludes that the JDT existed in this procedure because the two most disputed provisions during the ISD approval process were the two weakest points in its implementation process, and thus suboptimal. Thus, in order to avoid a complete collapse of negotiations, the ISD was characterised by ‘legendary ambiguity.’ This ambiguity resulted in substantially different interpretations and therefore different rules across the EU, as well as ‘gold plating’ which ‘stifled the benefits of a single set of EU rules and adding unnecessary burden and costs to European[financial] industry’ (Commission 2005: 6). Furthermore, the compromise with regard to parameters of regulated markets meant that there was no single passport for stock exchanges. The Council was unable to choose clearly between the two competing regulatory packages. Instead, the ISD compromise papered over the conflict with ambiguous clauses that effectively preserved the status quo ante. The paradox of the ISD negotiations was that although both coalitions preferred regulatory integration, they ended up with a fragmented status quo. Thus, the ISD merely postponed an agreement on a coherent set of EU-wide regulations.
After empirically showing how the ISD and its process led to the ‘lowest common denominator’ to be agreed upon, Kudrna analyses the MiFID and argues that the MiFID was much more successful thanks to the Lamfalussy process. He shows how temporality proves this, as one of the stated goals of the Lamfalussy reform was to speed up the adoption of financial market regulation. Although the agreement on the MiFID was only marginally faster than agreement on the ISD, the MiFID was much more detailed, being ‘467 per cent larger than the ISD text’ and incorporating seventy-three Articles with another ninety-six in its implementation compared to the ISD’s thirty-two. He concludes from this that the Lamfalussy procedure enabled the EU to deliver more comprehensive legislation faster, despite the prevailing conflict of preferences between the two advocacy coalitions. He then, level by level, analyses the MiFID to prove how the JDT was avoided. At Level 1, he shows how the MiFID’s slightly pro-Southern coalition position led to an immediate conflict of preferences, with the UK, Luxembourg, Sweden, Finland, and Ireland voting against its adoption. However, the Council vote suggests that the ‘Southern’ coalition was able to ‘force a choice of the protectionist equilibrium due to a coincidence that put its representatives into the key strategic positions in the Commission and the Council.’
At level 2, Kudrna analyses how the technocratic nature of the Level 2 committees allows them to discuss implementing measures to much greater depth than would be possible at Level 1. He gives evidence for less policy conflict in this level – for example members who have the voting right meet much less often to approve implementation measures. The ESC meeting summaries also show that delegations do express opposition to certain proposals, but solutions have been found by the time they are voted upon. Lastly, since its inception in 2001, the ESC never has to resort to a qualified majority vote. The success of Level 3 and the CESR is substantiated by the success of the de Larosière expert group in creating regulatory responses to the financial crisis. Lastly, at Level 4, Kudrna argues there was easier monitoring and enforcement, which shown by three infringement cases against the Czech Republic, Poland, and Spain, due to the failure of these countries to follow the new directive in a timely fashion.
This evidence suggests that at all levels, the Lamfalussy procedure operates more efficiently than the IDS in curbing preference and policy conflict.
IV. CRITICISMS
Overall, Kudrna provides a strong case for technocracy as a means of dodging the labyrinth of unsuccessful decision-making in the EU. However, this argument does not come without drawbacks. This form of exit strategy from the JDT, though perhaps beneficial in the context of financial market regulation, may not be the case for all markets. In this case, more far-reaching empirical data is necessary before it becomes possible for more market to delegate more power to technocratic committees. Furthermore, the Lamfalussy process is relatively new and though Kudrna argues that it has been beneficial to EU decision making short-term with the MiFID, questions with long-term viability should be addressed and more comparisons are necessary in order to form a stronger argument for causality. Moreover, some of his evidence for certain levels of the MiFID being successful is relatively weak and needs further explanation. For example at Level 3, he states that the successes of the de Larosière group substantiates the success of the CESR, but does not build upon this in great detail. Finally, perhaps another criticism of his argument would be the focus on how to escape the JDT and the negligence of certain democratic concepts. Amidst his inhabited glorification of this new exit strategy from the JDT, Kudrna does not acknowledge the theoretical arguments against delegating decision-making power to technocratic committees, which could incur an issue with the democratic issues of legitimacy and accountability. Because, by definition, technocrats are not elected officials, it may be possible to duck accountability in the short-term, however some vehemently argue that many indefinite policies and directives must be enacted, or maintained, by elected officials. It would be beneficial to Kudrna’s argument to respond to or address these concerns.
IV. CONCLUSION AND IMPLICATIONS
Kudrna concludes his argument by reinforcing that the restructuring of the EU decision-making process due to the Lamfalussy procedure has ‘provided the EU with an exit mechanism that prevents reoccurrence of suboptimal policies caused by the joint decision trap’. His final examinations highlight that the Lamfalussy procedure has made the EU better equipped to adopt and implement financial regulations, which is a valuable asset for the re-regulation of financial markets. In this way, Kudrna’s argument provides a strong case for a means of avoiding the decision trap in financial markets and potentially in other markets, as well as a strong case for technocratic measures being implemented within the EU. His argument in and of itself is strong; he acknowledges the conditions under which this delegation to technocracy must function in order for his argument to be valid, stating that the reforms of economic governance in the EU, and especially in the Eurozone, should be clarified beforehand. He also states that financial crises have shown the limits of the technocratic response and that without far-reaching macro reforms, the improvements that Lamfalussy technocracy can achieve would be limited.
References
- Auel, K., 2008. Still No Exit from the Joint Decision Trap: The German Federal Reform(s). German Politics 17, 424–439.
- Falkner, G., 2011. The EU’s Decision Traps: Comparing Policies. Oxford University Press.
- Holzinger, K., 2011. Environmental Policy in the Joint-Decision Trap? The Critical Balance between “Market Making” and “Market Correcting.” https://doi.org/10.1093/acprof:oso/9780199596225.003.0007 (accessed 11.28.17).
- Kudrna, Z., 2016, The EU’s Capital Markets Union [WWW Document]. Atlantic Council. URL http://www.atlanticcouncil.org/publications/reports/the-eu-s-capital-markets-union (accessed 11.28.17).
- Majone, G., 1998. Europe’s ‘Democratic Deficit’: The Question of Standards. European Law Journal 4, 5–28.
- Moravcsik, A., 2002. In Defence of the “Democratic Deficit”: Reassessing Legacy in the European Union. JCMS 40.
- Peters, B.G., 1997. Escaping the joint‐decision trap: Repetition and Sectoral politics in the European union. West European Politics 20, 22–36.
- Scharpf, F.W., 1988. The Joint-Decision Trap: Lessons from German Federalism and European Integration. Public Administration 66, 239–278.
- Holzinger, K., 2011. Environmental Policy in the Joint-Decision Trap?: The Critical Balance between “Market Making” and “Market Correcting.”