Select Committee on Treasury Written Evidence

Memorandum submitted by the City Remembrancer's Office of the Corporation of London


  1.  The Corporation of London has for some time been seeking to highlight the importance of thorough and detailed scrutiny of EU financial services legislation by Parliament, in addition to trying to ensure that directives which emanate from the EU are both principles-based and proportionate. Effective transposition into UK law through effective parliamentary scrutiny is closely connected to the successful pursuit of the Government's better regulation agenda as a whole. The City supports the Government's desire to bring about a fully functioning single market in wholesale financial services, recognising that such harmonisation would be beneficial to economic growth in the UK and EU.


  2.  The Lamfalussy scheme is primarily directed at the legislative and regulatory process (including the implementation and enforcement stages). So far, progress in establishing a framework for legislation and regulation has been generally reassuring, although it is too soon to reach a definitive judgement on all the facets of the application of the Lamfalussy approach because the process is still evolving, as are markets themselves. The implementation of Financial Services Action Plan (FSAP) directives is at an early stage; CEBS and the Committee of European Insurance and Occupational Pensions Supervisors (CEOIPS) became fully functional only at the start of 2004; the directive establishing Level 2 Committees for banking and insurance has recently been finalised; and it is so far hard to tell how efficiently and effectively the relationship between Levels 1, 2 and 3 is functioning. If problems do arise, it will be important to determine whether they result from any fundamental design flaw in the Lamfalussy framework or from its faulty implementation. Level 4 now needs more attention.

  3.  For the time being there is widespread agreement that the emphasis should be on improving the working of the Lamfalussy arrangements (for legislation, regulation and enforcement set out in the Lamfalussy report), which are likely to remain for the foreseeable future, and that every effort should be made to make them work, for example, by:

    —  ensuring that Level 1 legislation really is framework legislation and is not encumbered with "details" that would be better dealt within Level 2;

    —  deciding within Level 2 how much should be determined at that Level and how much should be left to implementing measures by national rule makers;

    —  using Level 2 procedures actively to ensure that regulation is kept up to date and mistakes in regulation are corrected quickly; and

    —  reinforcing the Level 4 arrangements for the enforcement of Community rules.

  4.  It is worth noting that the European Parliament's acceptance of the Lamfalussy framework, especially for the Level 2 arrangements, was made conditional on a change to the European Treaties that would allow the Parliament a power to "callback" Level 2 legislation. The Treaty establishing a Constitution for Europe provided such a power but now the Treaty has become defunct, some other way of meeting the Parliament's concerns may need to be found.


  5.  In the current climate when "Better Regulation" is top of the political agenda, business organisations have the chance, and the responsibility, to use the better regulation machinery and techniques to make a real difference to the quality of legislation. Techniques like regulatory impact assessment will only work if business shares details of its compliance costs with regulators and legislators. The full potential will only be achieved if business is prepared to deploy, where necessary, its own impact assessments where legislators and regulators have not done a thorough enough job.

  6.  The commitment to better regulation is widely welcomed. In particular, a systematic approach for the avoidance of "goldplating", for justifying the principles of new legislative initiatives by rigorous cost benefit analysis, and then by full regulatory impact assessments of specific regulatory methods; for using non-legislative approaches wherever possible; and for the ex post evaluation of the actual impact of regulations with a commitment to repeal or revise where the evidence so justifies. This should, however, be accompanied by more consistent implementation and enforcement of legislation. A crucial test of the Commission's resolve to give priority to such work will be the necessary reallocation of resources within the Commission services devoted to these objectives. To reinforce the commitment to and delivery of Members States' better implementation and enforcement agenda, it is suggested that a new combined unit should be established to monitor this within the Commission and reporting to the Internal Market and Competition Commissioners.

  7.  The new European Commission came into office in November 2004 determined to press ahead with the "better regulation" agenda. The agenda has received widespread support from practitioners in the City and beyond who have been calling for some time for both less and better legislation, and a genuine policy shift towards achieving more considered and intelligent regulation. At the EU and the domestic level, there is currently a major push towards these goals. The recent Commission Green Paper on Financial Services Policy emphasised the importance of thorough impact assessment and extensive consultation in all policy-making.

  8.  There is a growing realisation that the most effective legislation is produced in close consultation with key practitioners and stakeholders. This was the key finding of the report by the UK Better Regulation Task Force launched at the UK Presidency Better Regulation Conference in September 2005.

  9.  Better regulation has been one of the key priorities for the UK Presidency of the EU. The Corporation consulted with City practitioners and provided the Government with a "wish list" of priorities which we wanted to see on the agenda during the six months of the Presidency. Of particular relevance was the call to "establish systems and procedures which guarantee better regulation and simplification of legislation, and ensure the thorough use of cost-benefit analysis and regulatory impact assessment". The Corporation hopes to continue this dialogue with the Commission and other Member States holding the EU Presidency. It is hoped that as a member of the Six Presidency Initiative, the Austrian government will continue the UK's efforts. It appears that the Austrians are broadly supportive of the UK's work on impact assessments.

  10.  City practitioners feel there should be a major emphasis on the need for effective and consistent implementation of Financial Services directives across the EU as a whole. To realise the potential benefits of economic integration from EU financial services legislation while avoiding costly burdens on business, it is vital that there should be effective, proportionate and consistent implementation of legislation across the EU. Now that the legislative framework of the Financial Services Action Plan (FSAP) has largely been set, the City would like to see resources within the Commission shifted from legislative work to implementation and enforcement in order to tackle these issues and to pursue a system of reviewing the practical impact of legislation already in operation.

  11.  There is also the desire for initiatives to reduce the regulatory burdens on business, and to secure more evidence-based policy-making. At a time when the financial services industry is facing a period of enormous and costly institutional change as a result of the impact of the FSAP, it needs a substantial period to consolidate these changes effectively. Where further legislative moves are suggested these should first be justified through transparent and effective cost benefit analysis, and then involve a rigorous regulatory impact assessment in consultation with practitioners which demonstrates that the chosen regulatory route is the least burdensome to business within the spirit of the legislation. The Commission should seek to ensure that once transitional changes have been absorbed, regulatory/supervisory and other burdens are permanently reduced.


  12.  Clearing and settlement is a key part of the working of capital markets. When they are low-cost and efficient, they contribute to the effectiveness of the market. When they are expensive or inefficient, they inhibit the development of efficient markets. The value of the assets held and transferred through these systems means that their safety, soundness and reliability are vital.

  13.  Clearing and settlement in Europe is based on a patchwork of national systems which at the national level are generally efficient, sound and reliable, but lack the scale to bring their costs down to the lowest international levels. For cross-border transactions, however, clearing and settlement in Europe is neither efficient nor cheap. These features hold back development of a truly European capital market. The Corporation commissioned research[4] in 2004 which confirmed that the direct costs of clearing and settling an equity transaction in Europe are significantly higher than in the US.

  14.  Creating an efficient and integrated clearing and settlement infrastructure for Europe has been a goal for the financial services industry and the European Commission for several years. In April 2004 the European Commission published a communication setting out its objective as the "achievement of an efficient, integrated and safe market for securities clearing and settlement". In September 2005, Commissioner McCreevy re-emphasised the fact that improving the effectiveness of clearing and settlement in Europe is high on the list of priorities.

  15.  The Corporation of London therefore commissioned a new research report[5] to contribute to this debate by presenting the collective views of key stakeholders on the vision for the future of European clearing and settlement and the best way of achieving that vision.

  16.  The research demonstrates the belief of the industry that there is a scope to further reduce the cost and complexity of clearing and settlement in Europe. The research shows a need to simplify systems and procedures and to gain economies of scale through consolidation. This would reduce the cost of connection to multiple clearing and settlement providers and would reduce transaction costs. The research shows widespread support for developing a single clearing house (CCP—Central Counterparty Clearing House) for Europe which would reduce the amount of capital users would be required to commit to the clearing function. It should also be easier to achieve than the consolidation of settlement providers (CSDs) since CCPs are less driven by the particular procedures and the legal regime of a particular national market. This should be coupled with the harmonisation and consolidation of settlement.

  17.  There is general agreement that settlement consolidation is likely to result in a small number of regional CSD groupings, this giving the advantage of improved economy of scale whilst being more achievable than a pan-European megalith covering all markets. There is a clear majority view that to get the true benefit from each of these groupings they would have to involve corporate mergers. The key to efficient corporate consolidation and maximum economy of scale is the harmonisation of clearing and settlement practice in the markets concerned. Central clearing and settlement systems need to be able to process all markets in a standard way and users should be able to use the same messages and procedures for any market.

  18.  Two other aspects have been raised by the industry. First, there is agreement that the best way to maximise economies of scale is by consolidation, creating a single organisation, operating one set of systems with standard procedures, processing the greatest transaction volume. There is also a shared belief, however, that competition is the best mechanism for driving costs down and encouraging innovation. The reluctant view of the majority of practitioners is that competition will have to be sacrificed in order to achieve the consolidation which will create significant economies of scale.

  19.  Second, most market participants agree that clearing and settlement organisations should be not-for-profit utilities, owned by their users, but recognise that effective user governance is difficult to achieve. Separating the ownership of clearing and settlement organisations from exchanges is seen as vital to ensure that they operate to reduce costs and promote competition. However, many in the industry with direct experience of user owned clearing and settlement organisations take the view that they are neither as efficient nor as innovative as a commercially driven organisation would be. There is therefore a desire to establish a significantly improved model for user governance.

  20.  Looking to the future, the evolution of clearing and of settlement in Europe is likely to take two parallel routes. The most important development for improving the cost and efficiency of cross-border settlement in Europe is the evolution of standard procedures and messaging. It is the key to gaining economies of scale from corporate consolidation. Even without mergers, there would be considerable cost benefits for users if all the CSDs in Europe were operating according to common procedures and connection standards. There needs to be a concerted push to adopt common standards irrespective of the eventual corporate structure of the industry.

  21.  The goal of forming a consolidated European CCP is important as it would reduce transaction costs and the amount of capital employed by users, would have a positive impact on the competitiveness of trading and settlement, would allow users to switch trading venues more easily and would reduce the number of settlement transaction processed by CSDs, thereby encouraging them to improve efficiency. The main benefits of a European CCP will come from consolidation of clearing for the biggest markets, therefore the core of this concept must be the bringing together of LCH Clearnet and Eurex Clearing. This would pose a significant challenge to the current owners' belief in user ownership since it would require significant investment to fund it.

  22.  There has been debate on whether an EU directive would speed up the process of rationalisation. A significant minority of industry participants believe that it would galvanise speedier action. The majority, however, believe that it would be unlikely to help. It would take some time to agree a directive, there would be a danger of it gathering unrelated and undesirable provisions, and the authorities already have, in competition regulation, most of the powers necessary.

  23.  As the consolidation of clearing and settlement continues, many providers will become multinational monopoly utilities. There is concern that the financial services regulatory system, based on separate national regulatory bodies sharing the regulation of multinationals, will become an increasingly cumbersome mechanism for regulating these organisations. Competition regulation will also become an increasingly prominent element of the regulatory mix. A coordinated and more efficient regulatory structure will be needed for clearing and settlement in the future.

December 2005

4   NERA Economic Consulting, The Direct Costs of Clearing and Settlement: an EU-US Comparison, City Research Series No 7, Corporation of London, June 2004. Back

5   Bourse Consult, The Future of Clearing and Settlement in Europe, City Research Series No 7, Corporation of London, December 2005. Back

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