Select Committee on Treasury Written Evidence

Supplementary memorandum submitted by the Investment Management Association (IMA)

  1.  At the oral evidence session of the Treasury Select Committee Inquiry into European Financial Services regulation held on 14 December 2005, IMA was invited to expand on its comments that some aspects of the European process relating to MIFID had become politicised in areas that were essentially technical. We have identified several areas where this occurs:

    (a)  Where there is "unfinished business" in the Level 1 Directive that has then been passed to regulators to complete, rather than being teased out in the political process in which the Level 1 text was negotiated;

    (b)  Where further technical interpretation of provisions is required and this is used as an opportunity to continue the political debate; and

    (c)  Where further technical interpretation of provisions is required and regulators allow national interests to intervene rather than dealing with the technical issues presented.

    We offer an example for each category.


    2.  MIFID introduces new obligations for certain types of firms to publish quotes in "liquid shares" and to deal at their quoted price for orders up to a specified size, referred to as "Standard Market Size". While we think it entirely appropriate to deal with this at the technical, CESR, level, we understand that national politics has prevailed over a desire to find the right result for the market.

    3.  The definition of a liquid share is sensitive, since if the level of transparency is judged wrongly, it could have an adverse effect on the liquidity and efficiency of the market in those shares.

    4.  The Commission sought advice from CESR as to which shares should be deemed to be "liquid" and how to calculate Standard Market Size. As we understand it, CESR was given insufficient time to do a good fundamental analysis and was hampered by the poor quality of data that was submitted by the national stock exchanges. No attempt was made to determine what "liquid" meant in terms either of the efficient operation of the markets or of the impact on firms whose capital is at risk. Ultimately an arithmetic approach was adopted, which we understand had more to do with certain Member States not wanting to accept that few of the shares in their market were "liquid" than what was the right answer based on market analysis.

    5.  The Commission broadly accepted the advice offered by CESR and has subsequently been involved in negotiations to achieve an acceptable outcome to all. The issue of national options has loomed, with a proposal, for instance, to allow each Member State to nominate a certain number of domestic shares as "liquid". This clearly does little to achieve the aim of a more integrated market.

    6.  We do not think that the approach adopted, or timescale provided, is an acceptable way of intervening in working markets. There was, for instance, no thought given to introducing changes in stages, to check whether the changes worked or to iron out difficulties. The arithmetic response negotiated by CESR did not bring market knowledge with it and did not attempt any form of impact assessment. The pressure on the Commission to achieve a proposal that is accepted by a majority of Member States has so far produced a similar result. The proposals represent a very high risk approach to regulating markets.


    7.  The "negotiated" trade provision appeared part way through the consultation process to take account of non-standard transactions (eg a share sale that has a non-standard settlement period). However, this provision was changed in a second draft, because of a theoretical concern that it might be used by certain market users to avoid other obligations in the directive. What particularly worries us is that changes which could have a significant practical impact on market users (as opposed to brokers) appear to have been made through the intervention of two or three regulators with the CESR secretariat, without reference to the larger group, immediately prior to publication.

    8.  We were also concerned that the Financial Services Authority appeared to carry little weight in the CESR process, despite regulating by far the largest and most complex markets in Europe. Their experience and knowledge in many instances appeared to have been ignored.


    9.  The Level 1 text requires, essentially, that firms approach outsourcing with care, do not put critical parts of the business at risk and have the ability to monitor the arrangements that they set up. The Commission sought advice from CESR on expanding on the Level 1 text.

    10.  CESR chose to offer only one piece of advice, but this was a restriction that was potentially devastating to UK interests. This was to require that portfolio managers should only be allowed to outsource business within the EU. The UK-based asset management industry has operated for many years with a wide-range of outsourcing arrangements. To offer just one example, a manager offering a client exposure to the Japanese stock market will typically have some or all of this activity undertaken by a Japanese-based firm, possibly a subsidiary, whilst retaining overall responsibility for the operation of the account, its performance and for asset allocation. The CESR proposals would prevent a manager from ensuring his client's money is being managed by those with expertise in particular markets.

    11.  Clearly many if not most regulators do not have an understanding of the asset management business in the UK. But some regulators, typically those in countries which have a large back-office service industry, have a political/commercial interest in retaining as much business locally as they can.

    12.  Although dressed up as a protection to consumers, the advice in fact has the effect of protecting certain elements of EU national interests. Again, CESR offered little explanation of why they had chosen to advise in this way. Certainly there had been no impact assessment to the asset management industry, nor was there any attempt to justify restrictions for one industry against many.

    13.  We have outlined above areas where some aspects of the European process for implementing MIFID had become politicised in areas that were essentially technical. We would be happy to provide further evidence if required.

    January 2005

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