Bridging the capital markets integration gap: an operational framework for a supervisory efficiency rest

Europe’s capital markets are increasingly integrated — but supervision remains fragmented. Without a more coherent supervisory model, regulatory arbitrage and inefficiencies will grow. A new approach is needed.

The EU’s financial market supervision remains fragmented and misaligned with the depth of market integration achieved through initiatives such as the Capital Markets Union (CMU) and the Savings and Investment Union (SIU). Political resistance to centralising supervision, particularly under ESMA, has stalled reform, leaving a unthought system of national oversight, mutual recognition and limited supranational authority.

As Europe deepens capital markets integration, supervisory efficiency is now a critical obstacle to building a competitive single market for financial services. Divergent supervisory practices across Member States fuel supervisory arbitrage, weaken enforcement consistency and undermine trust in EU capital markets. Without a more functional framework to align supervision with market integration, the CMU and SIU will remain incomplete — limiting Europe’s ability to channel savings into investment and to compete globally.

Fabrice Demarigny, Forvis Mazars, discusses this challenge — and the political inertia surrounding it — in a recent paper he published for the European Capital Markets Institute (Demarigny/Thomadakis, ECMI Policy Brief). He also published a special issue article in Revue Banque in French (May 2025)[1], calling for a pragmatic, evidence-based approach to calibrate supervisory responsibilities according to market realities rather than political negotiation. That article laid out the key principles of for a supervisory efficiency test — as a way to guide future reforms.

This current article builds on that thinking and offers a more operational perspective on how the proposed supervisory efficiency test could be structured and used to inform supervisory choices across the full spectrum of market integration.  

“For firms, [targeted EU-level supervision] means fewer supervisory interfaces, clearer expectations and less duplication or contradiction. For our capital markets, it supports consistency, simplifies cross border operations and improves the functioning of the internal market.”

Verena Ross, ESMA Chair, Joint ESM FBF Conference, 5 June 2025

The fragmentation challenge

Despite sustained efforts to integrate financial markets, supervisory arrangements remain largely anchored in national jurisdictions, underpinned by a patchwork of legal instruments and institutional compromises. These include traditional national supervision under minimum harmonisation, mutual recognition mechanisms for passported services, colleges of supervisors for cross-border entities and, in a limited number of cases, direct supervision by ESMA.

This variety of supervisory arrangements reflects an evolutionary process shaped more by political expediency and crisis response than by a strategic blueprint for market oversight. In banking, the creation of the Single Supervisory Mechanism (SSM) responded to systemic failures. In capital markets, due to the variety of financial markets activities, institutional innovation has been far more incremental and uneven.

The result is a hybrid landscape in which supervisory effectiveness often depends more on the administrative capacity and political priorities of national competent authorities (NCAs) than on a voluntary EU supervisory policy.

Although ESMA has gradually accumulated technical mandates and regulatory convergence tasks, it still lacks the authority to systematically oversee or intervene in most national supervisory processes. There has been no deliberate or structural transfer of supervisory powers from NCAs to the European level.

Therefore, the current EU supervisory framework delivers neither full subsidiarity nor effective centralisation. It is a compromise structure that functions adequately in stable times but lacks resilience, coherence and strategic alignment when faced with rapid market evolution or systemic disruption. These structural limitations underscore the importance of developing a more functional approach to supervisory design — one that evolves in tandem with market realities.

A conceptual framework for supervisory coherence

The EU’s current supervisory architecture suffers from a lack of guiding principles to determine when financial supervision should remain national, when it should rely on mutual recognition and cooperation and when it should be transferred to the supranational level.

The premise is straightforward: the more integrated and cross-border a financial activity becomes, the more coordination or centralisation is needed to supervise it effectively. Conversely, when financial activity remains local in nature, national supervision is likely to remain the most efficient and proportionate model.

Close correlation between the level of market integration and the supervisory model is required to ensure effective oversight and market integrity.

This is the logic underpinning the proposed supervisory efficiency test — a structured, evidence-based approach for assessing whether current supervisory arrangements remain fit for purpose.

As proposed in the original framework, a supervisory efficiency test would map different models of supervision against the level of market integration — enabling policymakers to assess whether current arrangements remain fit for purpose.

“A supervisory efficiency test would transform the debate from one of centralisation versus subsidiarity into one of functional effectiveness.”

Fabrice Demarigny, Global Head of Financial Markets, Forvis Mazars in France

Supervisory models along the integration spectrum

To operationalise this logic, a supervisory efficiency test would be designed to classify different models of supervision along the spectrum of market integration.

• National supervision: At the most decentralised end of the spectrum are financial products and services that are distributed and consumed almost exclusively within national borders. In such cases, national supervision offers the most efficient solution.
• Mutual recognition: A step further toward integration are financial activities governed by EU-wide, principle-based rules and featuring some degree of cross-border provision. Mutual recognition of national supervisory decisions may offer the best trade-off where risks to the level playing field remain low.
• Supervisory convergence: Mutual recognition becomes less effective when cross-border activity increases and supervisory divergences emerge. In such cases, supervisory convergence must be reinforced, potentially through common methodologies, supervisory guidelines and recommendations or coordinated supervision exercises under ESMA’s lead.
• Colleges of supervisors: Where financial services are provided by larger cross-border groups or dominant market players, the coordination challenge increases. Here, colleges of supervisors can facilitate joint decision-making, though their effectiveness depends on the clarity of their mandate and the trust among supervisors.
• Direct EU-level supervision: At the most integrated end of the spectrum lie markets with full-scale harmonisation and a high risk of supervisory fragmentation. In such cases, direct EU-level supervision by ESMA is not only justified but necessary to ensure uniform rule application, avoid enforcement asymmetries and preserve market integrity.

Embedding the supervisory efficiency test

Embedding this logic – and the proposed test – into the EU regulatory process is the natural next step. The test should be used not only to inform debates about future reforms, but also to ensure that supervisory structures evolve dynamically, in line with market developments.

Rather than forcing political agreement on institutional change upfront, the efficiency test provides a structured, functional method to evolve supervision alongside market integration. It is not conceived as a rigid mechanism but as a flexible, function-by-function diagnostic.

The test could be applied at the level of entire EU legislative instruments or disaggregated into specific supervisory tasks. It enables policymakers to move beyond the binary debate of centralisation versus subsidiarity and focus instead on functional effectiveness.

A tool for regulatory realism

Ultimately, the supervisory efficiency test would be a tool for regulatory realism. It acknowledges the diversity of European capital markets while recognising the necessity of supervisory convergence in areas where integration is deepest and risks are most pronounced. It offers a pragmatic way to build supervisory coherence in step with Europe’s evolving financial markets.

For more details, read “A supervisory efficiency test for EU financial markets: Taking an operational approach to integration and oversight, Fabrice Demarigny and Apostolos Thomadakis, ECMI Policy Brief no 44 | June 2025”.

[1] See also the recording of the event organised by Revue Banque and AMAFI (Association française des marchés financiers), held on 10 June 2025. https://www.youtube.com/watch?v=yRSkEWK9bZA