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.
"LIQUID"
SHARES
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.
"NEGOTIATED"
TRADES
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.
OUTSOURCING
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
