Select Committee on Treasury Seventh Report

3  Case studies


33. In addition to the general discussion above regarding European policy-making for financial services, we have examined several existing and possible new directives to explore some of the general themes of our inquiry in more detail.

Markets in Financial Instruments Directive


34. MiFID is a wide-ranging Directive, constituting a major element in the EU's Financial Services Action Plan (FSAP). The Directive is intended to promote a single market for wholesale and retail transactions in financial instruments. MiFID widens the scope of investment services requiring authorisation by Member States and the range of investments falling within the ambit of regulation. It is also set to widen the 'passport' for investment firms, to facilitate cross-border activities across Europe.[48] However, MiFID does not significantly alter the boundaries of financial services regulation in the UK, because the UK already has regulation in most of the areas covered, although the Directive will require some of this existing regulation to be altered.[49]

35. MiFID also places organisational requirements on firms and markets, for example around independent compliance, risk management and internal audit functions and the identification and management of conflicts of interest, and sets limitations on out-sourcing. The Commission believes that, as a result of MiFID, consumers should be able to enjoy the same, high level of protection whether they choose a domestic service provider or a foreign one.[50]

36. We discussed MiFID with the witnesses that came before the Committee in December 2005. The Commission sent formal drafts of the MiFID 'Level 2' implementing measures, namely a draft directive and a draft regulation, to the European Parliament and the European Securities Committee on 6 February 2006.[51] Accordingly, we decided to invite supplementary written evidence, focused on MiFID alone, to gauge any subsequent reaction to the detailed draft proposals.[52] The responses that we received indicated that the Commission has taken industry input into account in preparing its final draft of the MiFID proposals and that this draft contains significant improvements over earlier drafts.[53]


37. The European Commission has never carried out a formal and exhaustive economic cost benefit analysis (CBA) of the impact of MiFID, because there was no requirement to do so when work started on the directive. In addition, the Commission believes that it is 'hazardous' to attempt to estimate the potential benefits of individual items of FSAP legislation, because "establishing economic cause and effect in such complex, interwoven markets is very difficult". Furthermore, the Commission has stated that "it is very difficult to predict what the impact [of MiFID] will be on individual firms, banks etc since it depends to a large extent on the commercial decisions which they will take." However, the "Commission is convinced that overall [the] benefits will outweigh the costs—although this may not be immediately apparent, since the costs will be front-loaded, while the benefits will take time to accrue".[54] The FSA had shown concern regarding the lack of a cost benefit analysis for MiFID. In July 2005, Sir Callum McCarthy, Chairman of the FSA, said:

It is deeply unsatisfactory that UK financial services firms face major changes, with the associated costs, for an initiative which has been subject to no comprehensive EU cost-benefit analysis to assess the specific contribution it might make to unlocking the prize of a more integrated European capital market. That kind of approach to policy-making cannot be sensible. Going forward, we will do all we can, alongside a growing band of regulators who share our commitment to assessing costs and benefits, to support Commissioner McCreevy's determination to make rigorous impact assessment a vital determinant of EU legislation.[55]

38. Sir Callum advised the Committee in November 2005 that "It is the case that the costs [of MiFID] are likely to fall particularly on the UK as the major wholesale market in Europe. Whether the benefits for Europe as a whole outweigh those costs, it is impossible to say because no proper exercise has been done."[56] The London Investment Banking Association believe that "the main benefit to be derived depends on the ability of firms to provide services on a cross-border basis across the EU. Benefits from MIFID therefore depend heavily on thorough implementation in other Member States, and recognition of passporting rights, with effective enforcement if this proves to be necessary."[57]

39. Despite the lack of any cost-benefit analysis at a European level, the Treasury has prepared a partial regulatory impact assessment, which noted that "about 3,000 to 3,500 firms will be affected of whom approximately 2 per cent are large firms, 23 per cent are medium-sized firms and three-quarters are small firms".[58] Furthermore, the FSA has a statutory obligation under the Financial Services and Markets Act (FSMA) 2000 to publish a cost-benefit analysis of any new rules, including those that it must introduce to implement European directives. The FSA has confirmed that there is sufficient information in the Level 2 proposals released on 6 February 2006 to carry out a cost-benefit analysis consist with their FSMA obligations.[59] However, in written evidence to us, the London Investment Banking Association recommends that, given that the implementation timetable is tight, the formal process of cost-benefit analysis should not be allowed to 'eat' into the implementation timetable.[60] Whilst we recognise the difficulty in estimating the costs and benefits of one part of an overall policy framework, the work involved in undertaking a cost-benefit analysis undoubtedly furthers and enriches the debate around what a measure is supposed to achieve and what changes firms will need to make to implement the measure. Accordingly, we are concerned that, to date, there has been no formal evaluation of the costs and benefits of MiFID by the Commission and will be extremely interested in the cost-benefit analysis on MiFID to be prepared by the FSA. We also welcome the new approach to cost-benefit analysis being taken at the Commission, which will require full assessments to be carried out on future proposals of this sort.


40. The Level 2 draft MiFID Directive states that "Member States may retain or impose requirements additional to those in this Directive only in exceptional cases where such requirements are objectively justified and proportionate so as to address specific risks to investor protection or to market integrity that are not fully addressed by this Directive, and provided that one of the following conditions is met … The specific risks addressed by the requirements are of particular importance in the circumstances to the market structure of that Member State".[61] The FSA had some concerns with this article, considering that, as drafted, it could require the FSA "to remove existing FSA rules that address risks to investors or to the integrity of UK markets". The FSA believed that it could prevent it taking action "that would otherwise be objectively justified and proportionate".[62] However, the Treasury was less concerned by this article, noting that it seeks to turn the aspiration to create a consistent regulatory regime across the single market into a legal provision.[63]

41. Ms Angela Knight, Chief Executive of APCIMS, told us that the she believed that UK industry was pleased that MiFID would be mostly implemented through a 'copy out' of the directive. She told us that a group of trade associations are working together in the 'MiFID Connect Project', which will prepare guidance for UK firms on the appropriate interpretation of the directive. She said that the "Treasury and the FSA are fully supportive of this approach, and therefore if in the future we shout about gold-plating, in fact we have done it to ourselves— and that is something we are not going to do".[64]


42. Based on oral and written evidence received by the Committee, it would appear that UK firms were well-prepared for the implementation of MiFID. The Association of Independent Financial Advisers noted that the "The UK is currently one of a very small minority of Member States who are aiming to meet the Commission's timetable. This could lead to the creation of an un-level playing field with major uncertainty for UK firms who are making use of the passporting rights".[65] Asked about the lack of awareness of the implications of MiFID in other European countries, Ms Knight said UK firms "will be very careful about implementing MiFID properly". In her view, there was a risk that UK firms are restrained through MiFID implementation "in a way that other Member States do not feel similarly constrained".[66] Whilst we applaud the leading position that has been taken by UK-based financial services companies with regard to MiFID, there is a clear risk that the Directive will not be promptly and fully implemented in all other European countries. It is also important that 'passporting' rights are recognised across Europe, in order to more readily allow UK-based firms to set up branches in other European countries and to ensure that the responsibilities of home and host regulators are clearly delineated. It is therefore essential that the Commission demonstrates its new focus on implementation and enforcement through ensuring that MiFID is implemented consistently across Europe.

43. Furthermore, the implementation of MiFID by national regulators will be a strong test of the Lamfalussy framework. Following the implementation of MiFID, we would encourage the FSA to consider reviewing the way in which the Lamfalussy process has worked in order to identify lessons for the future.

Possible directive regarding mortgage credit in the EU

44. The European Commission released a Green Paper on Mortgage Credit in the EU on 19 July 2005, with a consultation period until 30 November 2005.[67] Following this consultation period, Commissioner McCreevy said:

We are well aware that the EU mortgage credit market is a complex market, involving many varied areas of law and policy. As such, any initiatives we propose could take many forms, not necessarily legislative, and we will certainly explore all options open to us. Equally, we are well aware given the many areas in which initiatives could eventually be proposed, that we will have to ensure that any forthcoming work in this area is carefully focussed and prioritised, in order to achieve maximum benefits for all stakeholders, with the minimum level of burden on business … Moving forward, any initiatives we propose will be in a White Paper to be issued by the middle of next year. And I can assure you today, that we will make no proposals unless I am convinced that they will have the effect of increasing competition, efficiency and choice in the EU mortgage credit market, thereby supporting our endeavours to achieve the objectives of the Lisbon agenda, and, ultimately, to increase the global competitiveness of the EU.[68]

45. Mortgage markets have tended to remain national markets, rather than developing into a European market, as a result of differing land registration arrangements, repossession procedures and rights, availabilities of customer credit histories, and differing approaches to valuing a property for mortgage purposes. Accordingly, we asked the FSA, consumer and industry representatives about the need for a directive in the area of mortgage credit in the EU. Mr Tiner said:

We are very much in favour of seeing a more cross-border mortgage market; I think that would be good for consumers. However, I think there is a question about the best way to achieve it, bearing in mind some of the non-regulatory barriers such as language, tax and so on … I have a worry that the UK industry, which has to a large extent been passed on to consumers through the cost of mortgages, has in the last few years spent a huge amount of money, hundreds of millions of pounds, implementing the mortgage regulatory system here, which we do not want to have undone. The industry does not want it to be undone and consumers do not want it undone. There are some fears in some quarters about the unintended consequences of going towards a mortgage credit directive that unpicks what we have already done.[69]

46. The Council of Mortgage Lenders (CML) stated that "the UK market is itself responding to major challenges, principally in the field of regulation and new home buying and selling rules due in 2007. Regulation of mortgages came into force in October 2004. This has resulted in major changes that the mortgage industry is still absorbing. The costs of new statutory regulation, ultimately payable by consumers, have been substantial. The UK now has one of the most developed consumer protection regimes in the EU, and UK lenders have little appetite for further regulatory upheavals that are unlikely to bring benefits to themselves or their customers."[70] Mr Howard said that "there is not a lot that is coming through Europe that I feel consumers in this country will benefit from, especially when you look at things like the mortgage regulation. If anything, that adds to the costs to consumers here rather than providing any extra benefit."[71] The Commission's Green Paper was supported by a study produced by London Economics. In their response to the Green Paper, the Treasury and the FSA noted that "It is important as well that the Commission carries out a convincing economic impact assessment of any proposals. The London Economics study published alongside the Green Paper represents a first step, but is a long way short of the sort of rigorous cost benefit analysis that will be required to justify any specific action … The UK is … sceptical that Commission intervention in this area will prove effective in cost benefit terms, especially given the lack of evidence that action on this front will deliver greater integration."[72] Furthermore, the FSA has noted that this study "identifies that any benefits from integration would not be evenly shared across member states. The UK would be the least likely to gain because the major benefit comes from increasing market 'completeness'. So benefits to other Member States arise from increases in product diversity and accessibility to levels already seen in the UK."[73]

47. The written submission that we received from CML stated they do "not believe that integration can usefully be fostered by the promotion of cross-border borrowing by consumers. The cultural, legal and structural impediments to such activity are too great."[74] Mr Coogan identified several non-regulatory barriers that are preventing UK-based lenders selling mortgages in mainland Europe, including in particular, the lack of credit history information on potential borrowers in mainland Europe. However, Mr Coogan agreed that UK firms "would have a huge potential opportunity if markets across Europe were opened up because of the development of products for different people at different stages in their lives, lifetime mortgages and equity release as an example, and sub-prime for those who have had past debt problems".[75] It would be undesirable for the UK mortgage sector to implement new regulation as a consequence of European legislation if it has little or no incremental benefit to consumers. The case for a new mortgage directive remains unproven.

Possible directive in the area of cross-border clearing and settlement

48. The European Commission has indicated that a Directive in this area could be a means to liberalise and integrate clearing and settlement in the EU by giving all markets, clearing and settlement service providers and investors full choice on how and where to clear and settle cross-border transactions. Clearing generally refers to processes for managing risks between a trade taking place and it being settled, for example the risk that one counterparty to the transaction fails and is unable to complete the transaction. Settlement refers to the exchange of assets and assets between buyers and sellers following a trade.

49. The Commission's White Paper on Financial Services Policy 2005-2010 states:

Cross-border clearing and settlement infrastructures are far more costly than at the domestic level and their level of safety and efficiency is lower. The reasons for the high cost of cross-border transactions are technical, legal and fiscal obstacles. There is also no regulatory framework at EU-level. The Commission suggested in its Communication of 2004 that a framework Directive may be needed for an efficient, safe and cheap cross-border clearing and settlement industry. To test this possibility, the Commission is carrying out a very thorough consultation and impact assessment. Once this process is finished, while taking into account any new market developments, the Commission will decide during 2006 on the course to take and whether to come forward with a formal proposal.[76]

50. Commissioner Mr McCreevy said in September 2005 that "cross border securities trading remains very expensive: Up to 6 times the cost of domestic transactions … There is undoubtedly a growing conviction in the market that the creation of consolidated structures in the EU, such as a pan-European CCP [counterparty clearing house], could help the development of the European capital market … The solution must be market driven and I have no ideological hang-ups as to the degree or nature of the consolidation that should take place."[77] On 7 March 2006, Commissioner McCreevy and Ms Neelie Kros, Commissioner for the Internal Market, released a joint press release which stated:

Unless market players come forward with effective and realistic changes to improve the clearing and settlement of securities in the EU, the European Commissioners for Competition and the Internal Market intend to propose action on the basis of EU competition and single market rules before the summer break. The current fragmented national monopolies in trading infrastructures such as exchanges, clearinghouses and securities depositaries, create high costs for the EU economy and represent significant impediments to efficient cross-border trading in the EU. The securities industry needs to accelerate work on removing a number of barriers significantly, and provide a firm timetable for change.[78]

51. We asked witnesses from trade associations for their views on the desirability of European Commission intervention in this area. Ms Knight said that she there were "big question marks … as to whether actually creating a directive is going to bring the benefits that we all seek. A lot of the costs associated with cross-border clearing and settlement are (1) the fact that the clearing settlement systems do not use the same system; they do not use the same messaging. If we achieved harmonised messaging and the different systems are plugging together the arrangements in one country then conform better with the arrangements in another, and you get a big chunk of cost reduction; and (2) the current charging structures. We are quite open in our charging structures in the UK, but in much of Continental Europe there are different and closed charging structures so users are paying for things that they are not necessarily requiring. Open up that charging structure— and that is a competition issue— and this also starts to bring down the costs."[79] Mr Mullen added "MiFID is protean in its reach and is a huge directive. We are not sure, as I mentioned earlier— we have yet to have the implementing measures; they will not be out until January. We do not know to what extent MiFID may change the market and how it might affect the clearing and settlement arrangements. Until we see that knock-on effect it would not be timely for either the Commission or ourselves to act."[80]

52. Mr Tiner was more positive on the possible benefits of a directive in the area of clearing and settlement, although he noted that "is a sensitive subject because it is systemically important to each individual country".[81] Mr Tiner said that he would like to "see the Commission and the regulators putting pressure on the industry to sort this out. We should not underestimate the influence we have over the companies that can make the changes that are necessary in the market. We have done that successfully here. We started using market solutions as a tool to solve market failures quite successfully. We have done it in a number of areas now where you do not have to reach for the rule book or legislation; the market can sort the problem out. It is a great opportunity here for the European financial markets to sort this out. I would hope that the industry would come to the table.".[82] In written evidence to the Committee, the Treasury stated:

We support the emphasis being placed on action by the private sector to resolve problems. If it can be done it is clearly preferable to public sector action, particularly additional legislation. Therefore, we would urge the private sector, particularly the main infrastructure providers, to reflect on what they could do to meet the concerns expressed by the Commission. It is not possible to resolve all issues in the three month timetable set by the Commissioners for determining whether or not action is needed at the EU level. But firm commitments could be made to achieve progress on a realistic timetable.[83]

53. The high costs of clearing and settlement are borne by investors, either directly or through pension funds and other investment vehicles. Furthermore, the high costs of cross-border trading may be deterring retail investors from investing across Europe. It is therefore important that the additional cost associated with clearing and settlement across borders is reduced over time. We are pleased with the approach taken by the Commission in this area, which appears consistent with their 'better regulation' agenda. The Commission has indicated that it is willing to step aside if a market-led solution starts to appear in this area, and the Commission must deliver on this promise if a sensible solution emerges. We note that clearing and settlement has a systemic importance to a financial services market, although this is not a reason for inaction within a single European market for financial services. If the market cannot or will not address the high costs of clearing and settlement in Europe, it can have no complaints when policymakers start to become involved.

48   Financial Services Authority, Financial Risk Outlook 2006 Back

49   Ev 88 Back

50   European Commission, Frequently Asked Questions on MiFID: Draft implementing 'level 2' measures, 6 February 2006 Back

51   Council Directive 2004/39/EC Back

52   Treasury Committee press release number 24 of Session 2005-06, 1 March 2006 Back

53   For example, see submissions from the London Investment Banking Association (Ev 105), the Association of Independent Financial Advisers (Ev 33) and the FSA (Ev 80) Back

54   European Commission, Frequently Asked Questions on MiFID: Draft implementing 'level 2' measures, 6 February 2006 Back

55   Sir Callum McCarthy, Chairman, Financial Services Authority, FSA Annual Public meeting, 21 July 2005 Back

56   Treasury Committee, The Financial Services Authority: oral and written evidence, HC (2005-06) 655-i, Q 44 Back

57   Ev 106 Back

58   HM Treasury, UK Implementation of the EU Markets in Financial Instruments Directive - Consultation, chapter 7, December 2005 Back

59   Ev 80 Back

60   Ev 105 Back

61   MiFID draft Directive, article 4 Back

62   Ev 79 Back

63   Ev 88 Back

64   Q 30 Back

65   Ev 37 Back

66   Q 43 Back

67   European Commission, Green Paper, Mortgage credit in the EU, 19 July 2005 Back

68   Commissioner McCreevy, The Commission Policy on Mortgage Credit, Keynote speech at Public Hearing on Mortgage Credit hosted by the European Commission, Brussels, 7 December 2005 Back

69   Qq 85-87 Back

70   Ev 65 Back

71   Q 132 Back

72   HM Treasury and the Financial Services Authority, UK Response to Commission Green Paper on Mortgage Credit in the EU, 13 December 2005 Back

73   FSA, International Regulatory Outlook, November 2005, pp 13-14 Back

74   Ev 64 Back

75   Q 47 Back

76   European Commission White Paper, Financial Services Policy 2005-2010, para 4.1.4, p 12 Back

77   Speech by Commissioner McCreevy to the Irish Association of Investment Managers, 22 September 2005, Financial services in Europe today Back

78   European Commission Press Release, Clearing and settlement: Competition and Internal Market Commissioners will act unless there is further action from industry, 7 March 2006, IP/06/273 Back

79   Q 55 Back

80   Q 57 Back

81   Q 100 Back

82   Q 101 Back

83   Ev 89 Back

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