5 International standards for the prudential regulation of investment firms and banks

189. The prudential regulatory framework for investment firms is defined on a national level by national legislators. However, given that financial markets have become ever more international and the player’s active on those financial markets have thus also become more international, the need for more harmonisation of prudential frameworks is increasing.1 The European Union achieves harmonisation of legislation between member states via regulations and directives. This should result in a prudential framework which, at least between EU member states, is relatively equal.2 One of the technical committees of the International Organisation of Securities Commissions (IOSCO), comprising the securities regulators of the countries which are members of IOSCO,3 “was set up to study the issues related to capital adequacy for [investment firms] from a world-wide perspective”.4

190. Although national legislation was in place before this technical committee of IOSCO held its first meeting, it is the starting point of a more global perspective on the principles that should govern the prudential regulation of investment firms. As such, when discussing the merits of the current prudential framework for investment firms, it is useful to also discuss the principles and objectives as set out by IOSCO, as these principles should be shared and endorsed by the participating countries. These principles and objectives, despite not having a formal legal status, should be reflected in new legislation developed since 1989 by the countries that are members of IOSCO and thus the legislation currently in place.

191. The way the countries that are members of IOSCO have implemented these objectives can differ,5 however. When comparing the different prudential frameworks for investment firms globally, the framework employed in the European Union stands out, as this is the only jurisdiction where the framework intended for banks has also been used for investment firms until the coming into effect of the revised prudential framework in 2021. This notion itself will be explored later in this Chapter. It is remarkable enough, however, to warrant further discussions. Why is the banking framework used for investment firms in the European Union? As the European Union is the only jurisdiction where the banking framework is applied, one can also ask whether that means that other countries employ a suboptimal prudential framework, or vice versa: does the European Union employ a framework which does not cover the specific risks of investment firms?

192. It is useful to discuss the objectives and principles of IOSCO first as they set a high-level global framework, within which national legislators can design their own prudential regulations. A discussion on these global objectives and principles should be a prelude to a detailed discussion on the prudential framework in the European Union, which is included in Chapter 7, especially now that the European Commission has been reviewing the application of the banking framework to investment firms as of 20156 resulting in the publication of the IFR and IFD on 5 December 2019. Why was the banking framework employed for investment firms? What drawbacks does this banking framework have for investment firms? And what would be a better alternative if the conclusion is that the banking framework is not appropriate?