House of Commons - Treasury

Select Committee on Treasury Seventh Report

2 Legislative process

European Commission's financial services policy

4. In May 1999, the European Commission published a Communication containing a Financial Services Action Plan, which the Lisbon European Council endorsed in March 2000. The FSAP was a set of 42 measures intended to fill gaps and remove barriers to create a legal and regulatory environment supporting the integration of EU financial markets by 2005. It had three strategic objectives: the creation of a single EU wholesale financial services market; the creation of open and secure retail markets; and the introduction of state-of-the-art prudential rules and supervision.[2] The FSAP is now almost complete. Mr Ivan Lewis, the then Economic Secretary to the Treasury, confirmed on 2 May 2006 that of the 42 measures contained in the FSAP, 41 have been adopted. Commission communications or recommendations make up 16 measures, which do not need to be transposed into UK national law and regulation.[3] Of the remainder, 18 measures have been implemented in the UK, one measure almost implemented and the deadline for transposition has not been reached for the other seven measures.

5. The Commission published the first part of its evaluation of the FSAP on 7 November 2005, which concluded that the "FSAP seems to have worked extremely well as an over-arching programme and its completion within the deadline is regarded as a major achievement … However, there are definite flaws visible in the Financial Services Action Plan. These largely centre on the fact that, because it was so extensive, it was very difficult to balance the requirement for high quality legislation with the tight demands on timing."[4]

6. Under the European Commission led by President José Manuel Barroso, there has been a greater awareness of some 'regulatory fatigue' within the financial services industry as a consequence of the high volumes of legislation that have needed to be implemented within tight timeframes. Mr McCreevy has said that, whilst the FSAP has been largely delivered on time, "those agreements are only the first step. Now the measures must be properly implemented and enforced to ensure a level playing field across Europe. That is essential for the credibility and legitimacy of the whole project."[5] The Commission released a Green Paper and a subsequent White Paper on Financial Services Policy 2005-2010 on 3 May 2005 and 5 December 2005 respectively, presenting the Commission's financial services policy priorities for the period subsequent to the FSAP. The White Paper talks of "consolidating progress" and "completing unfinished business" in financial services, rather than envisaging a new action plan packed with new legislation. Certainly, in the Committee's discussions with Mr McCreevy and Commission officials, we received the strong impression that the Commission was committed to a period of 'bedding down' financial services legislation. The Government has strongly welcomed the Commission's White Paper, noting that they "believe it to be a pro-competition, pro better-regulation package of measures that sets the development of Europe's financial services on solid ground for the next five years".[6] The FSAP was a wide-ranging and ambitious programme of new legislation. As the FSAP comes to an end, the Commission has placed greater importance on ensuring consistent and workable implementation of the existing financial services legislation. We welcome this change of emphasis under President Barroso.

Desirability of a single market in financial services

7. The objectives of the Commission's financial services policy for the period 2005-2010 included "to consolidate dynamically towards an integrated, open, inclusive, competitive, and economically efficient EU financial market" and "to remove the remaining economically significant barriers in the market".[7] The evidence that we received indicated that there is now a single market in wholesale financial services in Europe. However, there is less evidence of a single market in retail financial services, with consumers preferring to shop for products in their own country. We note that there are significant, non-regulatory, differences between countries which inhibit the ability of consumers to directly shop across borders, including language barriers, national taxes and social security arrangements. Partly as a result of these differences, we noted an apparent lack of enthusiasm for European expansion shown by United Kingdom-based banks and insurers for cross-border retail of products. The CEA told us in Brussels that many domestic insurance companies were not significantly interested in cross-border retail of insurance products. Fiscal rules and legal rights of consumers were greater barriers to cross-border selling than regulations in the financial sector. In addition, cultural and language barriers were identified as reasons why consumers were unlikely to wish to purchase from companies based in other European countries. In any case, the CEA believed that retail insurance markets were already significantly competitive. Similarly, the CML believed that there were considerable opportunities for UK firms in Europe, but that the non-regulatory barriers were too great.[8]

8. The Association of British Insurers (ABI) were more upbeat on UK-based insurers' interest in conducting business in other EU markets, telling us that insurers have preferred to set up subsidiaries to do business in the markets in which they wish to operate.[9] In their submission to us, the ABI noted that "Europe's retail insurance markets remain largely local, for deep-rooted reasons relating to consumer preference, the local nature of risk, and national tax and social security systems. None of these can readily be tackled by EU legislation. We therefore welcome the Commission's statement that any future legislation should benefit from thorough consultation and rigorous cost/benefit analysis."[10]

9. Based on the evidence that we received, there is some evidence of financial institutions expanding through the acquisition of banks and insurers in other European countries. However, a single market in European financial services, with comparable products and services available to consumers direct across borders, does not appear to be a realistic proposition in the near future. The industry should look for ways to manage the non-regulatory barriers to cross-border sales of retail financial services products, particularly in areas in which the UK market has a product offering that is unavailable elsewhere in Europe. However, we recognise that, in some markets, such as the mortgage market, the non-regulatory barriers are significant and so, even in a consistent regulatory environment, there is unlikely to be significant cross-border growth. In these circumstances, the Commission should ensure that, in evaluating the likely costs and benefits of future proposals, it takes account of the fact that growth in cross-border sales is likely to be limited as a result of the non-regulatory barriers.

European cross-border consolidation

10. Retail financial services companies tend to expand into new countries through the acquisition of existing businesses, rather than through establishing new operations. Mr Ian Mullen, Chief Executive of the British Bankers Association (BBA), told the Committee: "In order to have an effective lending capability it requires years, indeed decades, of customer information and customer data in order to be able to lend effectively. It therefore is extremely difficult to enter a market and grow organically. Therefore the way in which one traditionally expands within retail banking is to acquire. As long as there are barriers to the ability to acquire banks across borders in many countries in Europe, then this will be a major inhibitor to the expansion of retail banking in Continental Europe."[11] We questioned the FSA on their willingness to allow a foreign acquirer to obtain ownership and control over financial services businesses operating in the United Kingdom. Mr John Tiner, Chief Executive of the FSA, advised the Committee that, as regards the ownership and control of financial and insurance companies, the nationality of a prospective acquirer of a UK firm was not a consideration for the FSA, but the possible impacts on the prudential safety of the firm and on consumer protection were relevant factors. Mr Tiner said: "I do not think London would have got to this pre-eminent position had there been a supervisory blockage to foreign investment; quite the contrary, we welcome it."[12] Based on our discussions with Commissioner McCreevy, we understand that the Commission does not see that its role is to encourage financial services firms to consolidate, because there was often not a business case for consolidation. However, Mr McCreevy has made it clear that he will not tolerate the retention or introduction of new artificial barriers to consolidation.[13] It is essential that the United Kingdom, through the European Council, supports moves by the Commission to prevent countries from erecting artificial barriers against consolidation in the financial services sector and exerts pressure on European countries that attempt to thwart cross-border merger and acquisition activity for unacceptable reasons.

Better regulation

11. We heard concerns that some financial services legislation arising from European directives was harming the United Kingdom's financial services sector. For example, Mr Stephen Sklaroff, Deputy Director General of the ABI, told the Committee: "It is certainly the case that the Insurance Mediation Directive (IMD) is an example of the kind of not terribly well researched or thought-through directive, and one that was not terribly well consulted on".[14] Mr Tiner agreed that there are elements of the IMD that have not produced all the anticipated benefits at a reasonable cost.[15] Commissioner McCreevy has shown a commitment to 'better regulation'. During 2005, he said:

Every new piece of legislation that crosses my desk has to show that it provides a clear benefit to the European economy. I ask simple questions: Is there a case for action? Is it the EU that is best placed to act? Is a regulatory proposal the only possible solution or are there less intrusive, less costly alternatives that can achieve the same objectives? Only if I get a 'yes' to all these questions will new proposals get my stamp of approval.[16]

12. The financial services industry associations who gave evidence to us broadly welcomed the Commission's emphasis on better regulation. However, Ms Sheila Nicoll, Deputy Chief Executive of the Investment Management Association (IMA), noted: "whilst we fully support the need for very close analysis, we sense that we may be about to enter a world of analysis paralysis, that sometimes such analysis can be an excuse for not taking action".[17] Mr Tiner told us that he "hugely" welcomed Commissioner McCreevy's commitment to do transparent cost-benefit analysis on new measures in the future, noting that the "signs are very positive, to back up Commissioner McCreevy's commitment".[18]

13. A change in the working culture at the Commission towards more proportionate, risk-based, policy making will not happen immediately. We welcome Commissioner McCreevy's assurances that the Commission will prove that new regulation will have a clear benefit to the European economy. It is essential that European policymakers ask and receive answers to the simple questions that McCreevy is posing: Is there a case for action? Is it the EU that is best placed to act? Is a regulatory proposal the only possible solution? To ensure growth and competitiveness in the European financial services industry, the Commission must now deliver on its promise to ensure better regulation principles are followed in its policymaking.

14. 'Red tape' does not come solely from governments or the European Commission. During the Committee's recent visit to Brussels, we heard examples of the Commission rejecting recommendations from CESR, the Committee of European Securities Regulators, because their proposals were too bureaucratic and costly to business. The initial guidance from CESR to the Commission indicated that all financial services firms may have been required to revise their terms of business and to reissue them to all clients, whether new or existing, once MiFID and the new EU regulations come into force (so-called 're-papering' of clients). However, through the Level 2 negotiations, it now seems likely that a smaller amount of costly 're-papering' of existing clients will be required than might have been the case.[19] There is also debate around the extent to which detailed prescriptive rules are useful to firms in implementing European legislation, or whether a broad principles-based approach is more appropriate. Mr John Tiner, Chief Executive of the FSA, said in November 2005 that "some member states have concerns that without the detail of regulation being the same in each member state, regulation will not foster the emergence of a single market in financial services".[20] Equally it is important that in implementing new requirements, UK-based firms reflect the balance between a principles-based and a rules-based approach that was taken in the preparation of the legislation.

15. National parliaments, national governments, the Lamfalussy committees[21], the Commission, the Council, the European Parliament and businesses themselves must all recognise that we have a joint responsibility towards ensuring that European financial services legislation is justifiable and proportionate.

Implementation and enforcement

16. Concerns were expressed to the Committee that the European Commission has historically placed too great a focus on designing and negotiating new financial services legislation and too little focus on ensuring consistent implementation of the legislation by national governments. For example, the IMA said in their written submission to us that "much of the attraction of joining the Commission has traditionally been drafting and steering legislation through the negotiation processes. We sense that implementation and enforcement has not necessarily been considered an attractive area in which to work. This attitude will clearly have to change, with reward systems and other structures adapted to the new approach."[22] Mr Sklaroff told the Committee that "there is a big challenge there because there are still many inconsistencies across the market which we would like to see sorted out."[23] The Financial Services Consumer Panel (FSCP) said that they "regard post-implementation evaluation as a high priority" for the Commission.[24]

17. We discussed with Commissioner McCreevy the changes in the Commission designed to better reflect the importance of post-implementation review of Directives. Mr McCreevy believed that, whilst some Commission staff were initially sceptical, most staff in the Commission had started to realise that post-implementation evaluation was a serious objective and would be followed through. Ms Nicoll told the Committee that she certainly thought that "there is a very different approach by both [President Barroso and McCreevy], in that they are taking very much a pragmatic commercially-orientated approach rather than a philosophical one. That is very important."[25] We are encouraged by Commissioner McCreevy's work to place greater emphasis on enforcement and implementation across the European Union, which entails a cultural change within the Commission. It is essential that the implementation and enforcement of MiFID and the other existing legislation become the priorities of the Commission in relation to financial services, rather than focusing on drafting and negotiating new legislation. We believe that there is the need for a period of 'bedding down' of European financial services legislation.

Consumer representation and protection

18. We asked the FSA about consumer input into the European legislative process. Mr Tiner advised the Committee that consumer representatives were sometimes "drowned out" in the consultation groups held by the Lamfalussy committees, given that there might be only one or two consumer representatives compared with, say, 19 industry representatives.[26] Mr John Howard, Chairman of the Financial Services Consumer Panel, told the Committee that the FSCP has recently been awarded a position on the 'Market Participants' Group' of CESR and his experience of the meeting was that it was "severely technical" and that his perception was that all the other participants, whilst attending in a personal capacity, came from the industry itself.[27] We discussed with officials from DG MARKT the need to have consumer input into the European legislative process. Officials noted that the Commission had attracted criticism for not getting enough input from consumers and was looking at ways to get useful input from consumers. The Commission's White Paper stated: "Establishing a permanent group of consumer representatives from across Europe is also planned, within which financial services issues of particular relevance to consumers will be discussed."[28] Mr Mick McAteer, Principal Policy Adviser, Which?, described these intentions as "encouraging", saying that it "could be very effective if it is resourced and staffed properly, and if it has the authority to call the Commission to account". He told the Committee: "I do not think it will have much impact if it is just another forum for discussion. It needs executive power to require the Commission to answer its recommendations and so on."[29] Mr Howard noted that there are organisations in the EU that did provide consumer-orientated input, such as the European consumers organisation, BEUC, and FIN-USE, although their input was "at quite a low level". He said "They have no greater opportunity to influence things than to send recommendations to the Commission or the various Lamfalussy bodies and suggest what they feel is the most appropriate way forward. There has got to be a much stronger structure than that." He also noted that there was a need for capacity-building at a national level in many other countries, to establish sufficient numbers of able national representatives to advise on a Commission or EU level.[30]

19. As European retail financial services markets become more open, it is important to ensure that consumers have the chance to have more input into the European legislative process. Presently, companies are organised into their trade associations, generally articulate and strong lobbyists, whereas consumers, particularly in Brussels, tend to be less well represented. We welcome the move in the Commission's recent White Paper on Financial Services Policy towards establishing a permanent group of consumer representatives from across Europe and would commend the Financial Services Authority's Consumer Panel as a possible framework to enable the consumer voice to be heard at all levels.

20. An important consideration for overseas customers seeking to buy financial products or services though UK firms is the level of consumer protection available in this area. Indeed, the Financial Services Consumer Panel has been pushing the FSA to explore its obligations to non-UK consumers who have problems with a UK-based firm. The Committee raised this issue in the oral evidence session with Mr Tiner.[31] Mr Tiner subsequently wrote to the Committee to clarify the FSA's powers and activities in this area.[32]

21. The FSA's statutory consumer protection objective makes no distinction between UK and non-UK consumers who deal with UK-based financial services businesses. Most of their rule-making powers also make no such distinction, although in exercising those powers, they must comply with EU Directives which may limit to certain limitations. The Financial Ombudsman Service is normally available to non-UK consumers, who deal with UK-based businesses. Furthermore, the Financial Services Compensation Scheme covers many claims of this type and many of the FSA's conduct of business rules apply, although there are exceptions to both of these. For example, the FSA does not require firms to provide key features documents to non-European consumers when selling regulated collective investment schemes. The FSA's prudential rules will generally apply if the firm has its registered or head office in the UK.

22. However, most of these protections do not apply when a non-UK consumer deals with an overseas branch of a UK-based firm, for example, a UK citizen living in Germany dealing with a branch of a British institution in Germany. The FSA argues that, in general terms, it will often not be proportionate to apply UK rules since the branch will be subject to local rules and consumers would probably expect to be protected under the local rules in any event. Non-UK consumers may also benefit from prudential regulation which applies to the whole firm. The FSA makes its own services available to non-UK consumers, for example, its consumer contact centre and its website.

The Lamfalussy structure

23. The FSAP was accompanied by a new approach to developing and adopting EU financial services legislation, known as the Lamfalussy approach, which involves setting out EU Directives in broad terms and then allowing committees of national supervisory authorities (including the FSA) to fill in, and amend, the details. The flexible nature of the framework leaves scope for substantial evolution and improvement as Directives are implemented. Under the Lamfalussy arrangements, the Commission proposes framework legislation and it is adopted under the 'co-decision' procedure— in other words, the Council and the European Parliament must reach agreement before a proposal can become law. This framework level is known as Level 1 of the Lamfalussy approach. It is supplemented at Level 2 by more detailed implementation measures, adopted by the Commission and endorsed by a qualified majority of Member States. The detailed Level 2 legislation is prepared by the Commission. It does this on the basis of advice provided by representatives of national supervisory authorities (including the FSA), acting through Level 3 committees. The Level 3 committees cover the main areas of financial services policy, being the Committee of European Securities Regulators (CESR), the Committee of European Banking Supervisors (CEBS) and the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS). In finalising their advice, the Level 3 committees consult extensively with providers and users of financial services. The Level 3 committees also aim to work together to foster supervisory convergence and best practice. Finally, at Level 4, the Commission ensures that Member States are complying with applicable legislation and the Commission pursues enforcement action where required.

24. Concerns have been expressed that political decisions cannot be resolved at Level 2 and disputes are sometimes passed down to Level 3 for regulatory authorities to debate. The FSA acknowledged that, in practice there can be "some overlap between the political and technical agendas".[33] However, the FSA "firmly believes that for the foreseeable future the Lamfalussy structures offer the best prospect for improving the European legislative process and for Member States to achieve supervisory convergence".[34] The BBA believed that the evidence to date does not support claims that the Level 3 Committees were taking decisions on a political basis. It argued that "In reality the extent to which a particular decision is 'political' depends upon how important it is perceived to be by politicians or interest groups. Generally if a decision is regarded as uncontentious or not having a significant effect on the industries or consumers of one or more Member States it is accepted as being technical. Otherwise a decision is at risk of being described as political by one or more interest groups or by politicians."[35]

25. In relation to this process, the FSA told us: "In sending calls for advice and mandates to the Level 3 committees, the Commission needs to be conscious of what is achievable within the timeframe allowed and to set realistic deadlines … The pressure to deliver advice to unrealistic deadlines … may mean that high level compromises are pursued when further technical work and a more measured approach might deliver a better result."[36] The FSA argued: "In each of the committees the pressure to achieve a consensus creates the risk of providing advice at a high level of generality which accommodates all opinions and existing legislative arrangements … CESR is currently reviewing its own procedures to determine whether it … should have the possibility of [qualified majority voting]. The FSA would support this."[37] Indeed, Mr Tiner told the Committee "if [CESR is] going to give crisp, clear advice to the Commission, [we do] need to work on the basis other than consensus where everybody has their little piece of legislation in there".[38] The Treasury also highlighted the difficulties that have arisen from the imposition of tight deadlines on the Lamfalussy committees when giving advice to the Commission on Level 2 measures, noting that this has meant that it was not always possible for the committees to subject their advice to full impact assessments, which has sometimes led to advice being "excessively detailed or prescriptive".[39]

26. Based on the evidence received by the Committee, the Lamfalussy structure appears to be functioning reasonably effectively. The main difficulties appear to stem from the tight timeframes that the Commission has typically imposed on the Lamfalussy committees to deliver advice. The Commission should consider slowing the legislative process where necessary, in order to ensure that the committees are able to fully investigate and resolve the issues involved. In addition, it is essential that the Treasury attempts to ensure that any clearly political matters are resolved in the Level 2 committees—with genuinely technical input provided by the Level 3 committees at this stage—rather than leaving them for the FSA and other European regulators to debate later in the Level 3 discussions.

The role of the European Parliament

27. In their written submission to us, the Association of Private Client Investment Managers and Stockbrokers (APCIMS) commented:

The European Parliament, and particularly the ECON Committee, have taken an active involvement in the FSAP. ECON has amended significantly the main Directives in response to industry requests, has produced reports from its own initiatives and has sought to understand the issues. However … it plays no formal part after the Directive has been created and only considers the CESR measures as a result of an agreement between the Chairman of CESR and the Chairman of ECON.[40]

28. The IMA were also complimentary about the role of the European Parliament in relation to European financial services saying that "on policy issues the Parliament's contribution has been very valuable … We have found MEPs accessible. They have been willing to listen and understand the business, as well as to challenge where appropriate. We have been particularly struck by how MEPs have worked effectively across both party and national lines, recognising the technical rather than political nature of much of the work involved."[41] The London Stock Exchange agreed that the European Parliament "had made a positive contribution to the negotiations … from a UK perspective".[42]

29. The 'comitology' arrangements under the Lamfalussy structure mean that the European Parliament has a formal role in the consideration of new legislation only at Level 1. However, in written evidence to the Committee, the FSA added that, during the Lamfalussy Level 2 process, the European Parliament "is kept fully informed and the utmost account will be taken of its view".[43] The Commission's Green Paper on Financial Services Policy 2005-2010 stated that the European Constitution was "important for the medium term continuity and sustainability of the Lamfalussy process, since the 'sunset clauses' in the securities area come into effect from 2007 onwards. Under these clauses, delegated powers to the Commission to adopt implementing measures through comitology (level 2 of the Lamfalussy process) will expire, unless the Council and the European Parliament explicitly agree to extend them."[44] In its response to the Commission's Green Paper on Financial Services Policy 2005-2010, the FSA stated that, in the event that the Constitution Treaty was not ratified, it considered it essential that priority be given to settling the question of the Parliament's role in relation to delegated 'level 2' legislation.[45] The London Investment Banking Association agreed with these sentiments, stating that "The formal status of the [European] Parliament in developing 'Level 2' implementing measures needs to be clearly established by agreeing effective 'callback' procedures … discussions are under way on alternative mechanisms to do this, and it is important that they succeed."[46] The Commission's White Paper on Financial Services Policy 2005-2010 merely notes that "The debate on comitology reform is particularly important".[47]

30. The Constitutional Treaty has not yet been ratified by all Member States and, under present arrangements, cannot enter into force until full ratification has been achieved. In the absence of the Treaty, the EU Institutions are in the process of negotiating a new inter-institutional agreement on comitology, on the basis of a Commission paper first proposed in 2003. This may formalise the European Parliament's status in level 2 Lamfalussy implementing measures and, in particular, its right to recall for review certain implementing decisions with which it disagrees.

31. It appears to us that the Lamfalussy structure is developing well. We consider it important that the present ambiguity regarding the role of the European Parliament in the process is removed. The evidence we have received indicates that the European Parliament is playing a constructive role in the legislative process for financial services, particularly in its contribution to scrutiny of delegated implementing measures in the Lamfalussy structure. We consider that the European Parliament should have a formal role in examining Lamfalussy level 2 implementing measures within a reasonable timeframe, with the ultimate sanction of blocking or "calling back" any measures which it considers unacceptable.

32. We understand that a formal inter-institutional agreement between the Parliament, Commission and Council on the future operation of the comitology process is shortly in prospect. We recommend that the Government should, in its response to this report, provide full details of the draft inter-institutional agreement on comitology procedures, together with the Government's assessment of the agreement and its application to the Lamfalussy process.

2 Communication of the Commission, Financial services: Implementing the framework for financial markets: Action plan, 11 May 1999, COM(1999)232 Back

3 HC Deb, 2 May 2006, col 1442W Back

4 European Commission, FSAP Evaluation Part I: Process and implementation, 7 November 2005, p 38 Back

5 Speech by Commissioner McCreevy, Assessment of the integration of the Single Market for financial services by the Commission, CESR, Paris, 6 December 2004 Back

6 Ev 86 Back

7 European Commission, White Paper on Financial Services Policy 2005-2010, 5 December 2005, p 3 Back

8 Q 47 Back

9 Ev 27 Back

10 Ev 25 Back

11 Q 39 Back

12 Q 90 Back

13 Speech by Commissioner McCreevy, The Development of the European Capital Market, London School of Economics, 9 March 2006 Back