Regulatory Maze: Can Europe Afford It?

In a recent speech to the European Commission, Mario Draghi highlighted how European firms are exposed to a large and growing number of regulations. A prime example is the banking sector, where banks must comply with regulatory requirements common to non-financial companies, but also with specific provisions of central banks and banking supervisory committees (such as the Basel Committee). Another case is that of ESG regulation. In recent years, the European Union has issued several directives to push companies to be more sustainable. From the SFDR – which aims to promote and support sustainable investment practices in the financial services sector – to the CSDR – which this year introduces the obligation to prepare sustainability reports – European firms are coping with an increasing number of ESG regulatory requirements. According to Datamaran, the number of regulations and initiatives concerning non-financial issues increased by 72% from 2013 to 2018. Notably, while over the period 2019-2024, 3,500 pieces of legislation were enacted in the US, 13,000 were passed in the EU in the same period of time. Hence, regulation is larger and growing faster than in comparable economies. Moreover, EU legislation is subject to frequent changes over time and requires a national transposition of EU laws. Notably, at the local level, firms can be exposed to additional national rules other than EU ones. The presence of multiple regulatory layers implies that more than one regulation can oversee the same issue leading to so-called regulatory fragmentation. Despite the mounting evidence that regulatory fragmentation exists, its pros and cons are still under debate.

On the one hand, academics point out that the presence of multiple regulators is beneficial for protecting investors, as regulators with different knowledge and expertise can complement their enforcement activities, enhancing  the accountability of regulatees. On the other hand, there is a concern that the existence of multiple regulators is costly for firms, especially when regulators do not coordinate. A lack of coordination can lead to redundancies and inconsistencies among regulations. According to a Business Europe gap analysis of 13 EU laws, 169 requirements were duplicates, 11% of which included inconsistencies. Furthermore, it can generate uncertainty among firms about which regulations they should follow, increasing the compliance costs. In addition, firms can prioritize compliance with regulators over which they have a stronger influence. Under this perspective, the presence of multiple regulations may not be optimal for firms. In line with this idea, recent empirical evidence shows that regulatory fragmentation is associated with lower firm productivity, profitability and growth. These results are consistent with Draghi’s claim that EU regulation is “a major source of regulatory burden, magnified by a lack of guidance to facilitate the application of complex rules and to clarify the interaction between various pieces of legislation.” Draghi encouraged the reduction of regulatory obligations for EU firms by 25% (50% for SMEs), to protect their competitive advantage and spur innovation. Carrying out such a decrease is not easy, as shrinking the regulatory burden for firms needs to be balanced with adequate protection of investors. Furthermore, given the potential synergies among regulators, for the reduction to be effective, regulators should cooperate and coordinate their actions. The joint effort of regulators is a key prerequisite to maintaining investor protection and integrity of financial markets while depressing compliance costs for firms. Yet, coordination of regulators can be a challenge, as regulators often protect specific interests and compete with each other to be the most powerful and effective. Yet, overcoming such dynamics seems crucial to loosen the regulatory burden on firms and ensure that compliance with regulation is not an impediment to the success of firms.