Publications on the internet
General Committee Debates
European Committee Debates
|©Parliamentary copyright||Prepared 6th April 2011|
Publications on the internet
General Committee Debates
European Committee Debates
Short Selling and Credit Default Swaps
The Committee consisted of the following Members:
Alison Groves, Committee Clerk
† attended the Committee
Mr James Clappison (Hertsmere) (Con): I hope to do better than that, Miss McIntosh; I am looking at the clock so that I can time myself. Before I begin, however, I must say what a great pleasure it is to serve under your chairmanship. As you suggest, it might be helpful to the Committee if I explain briefly the background to the documents and the reasons why the European Scrutiny Committee recommended them for debate in this Committee.
The European Commission held a four-week public consultation on short selling in June and July 2010, following the various restrictions on short selling imposed by most member states in the autumn of 2008 and the concerns expressed by some Governments about the possible role played by credit default swaps in relation to the prices for Greek sovereign bonds in the spring of 2010. In September last year, in the draft regulation that we are discussing, the Commission proposed introducing a number of permanent measures, as well as some temporary measures to be employed in adverse circumstances, on the short selling of financial instruments.
The opinion from the European Central Bank comments on the draft regulation, supporting the objective of the proposals and suggesting 11 amendments. It is expected that the Hungarian presidency will seek a general approach—that is, an outline agreement—on the proposal at ECOFIN, the Economic and Finance Council of Ministers, in May 2011. As the Government have pointed out to the European Scrutiny Committee, the Commission has failed to produce an evidence base for the proposals in the draft regulation and a proper cost-benefit analysis. There are outstanding contentious issues, particularly in relation to sovereign debt and the Meroni principle, which is that only closely defined executive powers, rather than discretionary ones, should be devolved to EU agencies such as, in this case, the European Securities and Markets Authority.
The European Scrutiny Committee felt strongly that the presidency’s wish to secure a general approach on the matter before the issues are resolved was wholly unjustified; we felt that a rushed conclusion would inevitably result in poor legislation. Rather than clearing this document of the need for scrutiny, the Committee therefore recommended that it be debated today, so that Members can examine these contentious matters.
The Financial Secretary to the Treasury (Mr Mark Hoban): It is a pleasure to serve under your chairmanship, Miss McIntosh. It is worth picking up where my hon. Friend the Member for Hertsmere left off. This debate was originally scheduled to take place before the March ECOFIN, but the presidency, having reflected on the significant issues that were left to be resolved, delayed consideration to the May ECOFIN. This opportunity for the Committee to debate the subject is timely; the debate will help to inform the Government’s strategy for trying to resolve the outstanding issues that my hon. Friend raised.
I am not sure how widely understood short selling is by Members across the Committee; for the benefit of those who are fresh to the subject, I shall say a little about it. Short selling is a legitimate, long-standing investment technique that makes a positive contribution to the efficient functioning of the European market. It is a source of liquidity and it helps with price discovery—that is, in determining the price to be paid for a security through supply and demand.
How does short selling work in practice? Often, the securities are borrowed from a third party with the intention of buying back identical assets at a later date to return to the lender. The aim of the short seller is to profit from a decline in the price of the assets between the sale and the repurchase, as the seller will pay less to buy the assets than the seller received for them. Of course, the short seller will incur a loss if the price of the assets rises; they will also incur costs, such as a fee for borrowing the assets. Short selling is not a one-way bet; those who use the strategy can make or lose money.
We are aware that short selling, particularly in turbulent markets, can have negative impacts. That concern was particularly acute in the financial crisis, when a number of EU member states and the USA adopted emergency measures to restrict or ban short selling. They acted due to concerns that short selling might aggravate the downward spiral in the prices of shares, notably in financial institutions, in a way that could ultimately threaten their viability and create systemic risks. They acted in times of crisis, taking precautionary measures that were not necessarily based on sound evidence.
The UK also took action. The Financial Services Authority introduced a temporary ban on short selling in September 2008, which expired in 2009. The UK retains public disclosure requirements in respect of securities in the financial sector, and securities for which there is a rights issue in progress. Those measures were put on a firm legislative footing, with cross-party support, in the Financial Services Act 2010.
We are here to debate the EU’s proposed short selling regulation, which represents a more stringent package than the packages in other jurisdictions such as the US, Hong Kong and Australia; it is certainly more stringent than the measures that we put in place in the UK. The measures that we are discussing aim to harmonise regulation of short selling by EU member states, and stem from a 2010 report by the Committee of European Securities Regulators, or CESR, which recommended a pan-European short selling disclosure regime.
The Government support efficient, stable and sound markets across Europe, and regulation that promotes such markets. The regulation that we are discussing looks to improve transparency, create a single legislative framework, and create workable and consistent powers for regulators. We are behind those aims, but it is imperative that regulation is built on a sound evidence base, with robust quantitative cost-benefit analysis. That is lacking in the short selling regulation and in other European dossiers. Indeed, as my hon. Friend the Member for Hertsmere may remember, I have highlighted that lack to the European Scrutiny Committee in this place, and to the European Union Committee in the other place. I am keen for Ministers and the Committees to work together to tackle the problem, perhaps through discussion with other Parliaments.
The initial proposals were poorly drafted and contained a number of ambiguities. Needless to say, the UK raised concerns on a number of issues, chief among them the proposed restrictions on short selling of sovereign debt and on credit default swaps. There are some vociferous supporters of the restrictions, who regard them as necessary to tackle speculation, despite there being no evidence to support such restrictions. There is, however, evidence to the contrary, and we believe that too broad a restriction would have a detrimental effect on the liquidity of sovereign debt markets, particularly those of smaller member states. Of course, we are determined to avoid any detrimental effect on UK gilts. We have worked tirelessly to ensure that the regulation will foster liquid, efficient markets, rather than restrict activity unnecessarily and bring about negative unintended impacts on member states. I assure hon. Members that the current draft is much improved as a result of our efforts.
There are some outstanding issues on articles 12 and 24 that need to be resolved before the Council agrees the general approach at the May ECOFIN. Trialogue discussions between the presidency, the Council and the European Parliament have begun, and the UK leads the way in those discussions. We are absolutely committed to working with other member states to ensure that the final regulation is proportionate, evidence-based and robust.
Chris Leslie (Nottingham East) (Lab/Co-op): I wonder if I might ask a series of short questions together, rather than asking them one at a time, which would obviously take longer. Will the Minister outline where in the EU processology we are with the regulation? I understand that we are still technically at the draft regulation stage, even though there have been five ministerial meetings and a couple of attaché meetings to try to finesse the development of the regulation. Are we still essentially at draft regulation stage, and not at a stage at which something will go to the Council? I think that there is an ECOFIN meeting coming up in May, but will the Minister tell us at what point, if at all, there will be a parliamentary process in which we can discuss a final version of the regulation that emerges from the negotiations that are taking place? Or is this likely to be the main parliamentary occasion on which to debate the issue? That is a technical question.
What representations has the Minister had from UK hedge funds and other financial services organisations about the proposal? Clearly, a lot of the industry that would be affected by any regulatory change is in London. I do not want the Minister to list individual companies, but perhaps he could give us a flavour of the volume of representations that he has received, and say whether those representations will be put in the public domain if we want to look through them in more detail; that would be quite useful.
Which countries are arguing most vociferously for the proposals? Are they, as might be expected, Greece, Ireland, Portugal and so on—the countries whose sovereign bond markets have been most affected by alleged speculation on their sovereign positions—or do the proposals have a broader support base across the EU?
Finally, I have a question that is, I suppose, more on a point of principle. A lot of people will be most interested in uncovered or naked short selling, in which the person making the short position does not have ownership of the asset on which he or she is seeking insurance; in other words, they do not have any skin in the game, as the phrase goes. They are essentially taking an insurance position on an asset that they do not own. Do the Government have a view on any of the worries or anxieties about the gambling connotations of naked short selling, or do they think that uncovered short selling is just as legitimate as traditional short selling, in which the asset tends to be held or borrowed?
Mr Hoban: On process, as I indicated in my opening remarks, a trialogue has started with the European Parliament and the European Commission. However, it started in the absence of a general approach agreed by ECOFIN; such an agreement will not take place until the May ECOFIN at the earliest. The next ECOFIN is the formal ECOFIN, which cannot agree a general approach, so that decision will be deferred until the May ECOFIN.
There has been quite a lot of engagement by the UK and financial services institutions based in London. Their representations reflect concern about UK sovereign debt and the way that it is dealt with, but London is also a venue for trading sovereign debt from other countries, so there have been a range of views. The Debt Management Office has made its views clear to Government, and has been quite influential in shaping our views. The hon. Gentleman mentioned hedge funds; their concerns have been about disclosure rules in particular. There was, I think, a reluctance on the part of some to facilitate wider disclosure of positions taken. As he will be aware from where we are at the moment with regulation, there are various rules to promote and encourage disclosure as part of creating a transparent market.
On the question of whose are the main voices in discussions on the subject in Council, I would say that the French and the Germans are particularly keen on the regulation. It is not entirely clear that those countries have necessarily been on the front line of recent speculation, but they are the most in favour of some of the measures in the regulation. There has been strong support for the regulation from the Commission and the European Parliament. I have identified the need for evidence to underpin the recommendations put forward by the Commission; that is a point that I have made directly to the Commissioner, and I know that others have done so, too.
I think that people who engage in naked short selling—there is a danger of extending this metaphor too far—do have skin in the game, in the sense that if they have sold an asset and the price rises before they have the chance to repurchase it, they will lose money. There is an issue around settlement risk as well. The evidence on naked short selling indicates—the FSA did a lot of work on this in advance of the Financial Services Act 2010—that there are benefits to naked short selling. The selling improves liquidity in markets and promotes price discovery, which is why one of our important improvements is to ensure that when it comes to the short selling of sovereign debt, gilt-edged market-makers, who are pivotal in the role of selling debt, are exempt from the ban on the short selling of sovereign debt.
Kelvin Hopkins (Luton North) (Lab): I am not an expert in the area but one is concerned about the implications for the stability of countries. Our papers refer specifically to the Greek crisis and the role of short selling, with reference also to Ireland and possibly Portugal. What is the Government’s assessment of the role of short selling in those crises? Was it substantial? Is it something that everyone should be worried about, or is the risk worth accepting for other benefits?
“The empirical investigation that has been conducted by the task force on how the sovereign CDS and bond markets interact, provides no conclusive evidence that developments in the CDS market causes higher funding costs for Member States.”
The evidence base suggests that CDSs did not play a role in the creation of the crises, as is sometimes suggested, and it appears that the market is about the fundamentals of those countries, rather than driven by speculation about CDSs.
Kelvin Hopkins: If that is the case, what is the motivation behind wanting to regulate short selling, if it is not actually damaging and might even be beneficial? As I said, I am an innocent in such matters.
Mr Hoban: That is an innocent but powerful question to which there is no clear answer, in terms of looking at the evidence base for taking action. There has been a lot of clamour for action to be taken on short selling and CDSs, which goes back to my earlier point when I echoed the remarks made by my hon. Friend the Member for Hertsmere. In the debate about increasing financial regulation, none of us has any qualms about toughening
Kelvin Hopkins: Britain is outside the eurozone, which has problems that are not of primary concern to us—although obviously if the eurozone had serious economic problems, that could spill over a bit. Given that we are outside the eurozone, many people would argue that we should regulate our market, and that the eurozone should regulate its market; we should not be party to any regulation in the eurozone, and it should not take a role in regulating our financial markets. Is that correct?
Mr Hoban: The hon. Gentleman makes a deeper philosophical point about what should or should not be regulated, but the reality is that financial services are covered in the Single European Act. UK financial services benefit hugely from easy access to financial markets across Europe and we have a strong interest in ensuring that we remove barriers to trade within Europe.
There is evidence to suggest that liberalisation improves overall economic growth. A recent study showed that the markets in financial instruments directive, which principally affects wholesale markets, has led to an increase in European gross domestic product of 0.8% since its introduction, so there are some very good reasons for having consistent regulation across Europe. What is important is ensuring that regulation promotes economic growth and efficient and transparent markets and does not create a barrier around Europe.
Kelvin Hopkins: There is a distinction to be drawn between the short-term, overnight selling and buying of financial instruments almost minute by minute and trading—imports, exports or whatever. Restricting the volatile, short-term, casino activity would not have any damaging effect on overall trade. Is that a fair comment?
Mr Hoban: If the hon. Gentleman spoke to the directors in businesses in his constituency—I think Vauxhall Motors has a plant there—he would find that they use hedging techniques to protect their businesses against fluctuations in exchange or interest rates, some of which will be a form of short selling. To regain the trust and confidence of the country more widely, the financial services sector must tackle and re-emphasise the connection between some of the financial services activity that takes place in the City, Canary Wharf or elsewhere and the rest of the economy. A number of straightforward manufacturing, commercial or retail businesses use some of these instruments as a means of protecting their revenue, giving greater predictability to their business and, yes, helping to improve their trade in the long term.
Kelvin Hopkins: As it happens, the Minister is right; one of my dearest friends, who has now passed away, was the banking and finance manager at Vauxhall Motors in Luton, and a member of the Labour party. He did not see what he did as very moral necessarily. He was speculating in currency and finance to make a bit of extra profit for the company. He was not trading in motor vehicles or parts.
I am still waiting to be convinced that such financial activity is really valuable. I have to say that I am a strong supporter of a Tobin tax—or the Robin Hood tax, as some might say—which is designed to stop that kind of very short-term, speculative gambling in financial instruments, while not interfering at all with substantial movements of finance across national boundaries or with buying and selling for trading purposes. I am still waiting for the Minister to convince me that such activity is an essential part of the economy.
Mr Hoban: Conservative Members have sought for many years to persuade the hon. Gentleman of the merits of free markets and competition and trade in those instruments, so I suspect that we will not be able to achieve that in two and a half hours this afternoon. His late friend might have questioned the morality of what he did, but, to look at it in a different way, he achieved greater certainty about currency prices or interest rates, and as a consequence the customers of Vauxhall Motors could be certain that they got a better deal. A real benefit flows to the consumers from some of these trading strategies and approaches. The organisations who lend out stock for stock-lending as part of hedging are actually our pension funds. They get a fee for doing so, which augments the pensions that we receive.
It would be a mistake to see these approaches as something that happen in isolation from the rest of the wider economy; to think about it in the context of transactions between traders in financial services, and not think about the wider links that these product strategies have to the rest of the economy.
Kelvin Hopkins: I have one last point. One was not suggesting that we should be restricting trade in motor vehicles, motor vehicle parts or whatever. One distinguishes that from the volatile gambling in financial instruments. I suspect also that the benefit of the gambling was more for the interests of the shareholders and the profits than for customers or even maybe the workers and employees of Vauxhall Motors, but I will leave that with the Minister.
Mr Hoban: All that I would say is that profits earned by people such as Barcap or Goldman Sachs are returned through high dividends to their shareholders, and to the pension funds that hold those shares. I encourage the hon. Gentleman to think more widely about the web of finances, and remember that it does not just stop at the edge of the trading floor.
That the Committee takes note of European Union Document No. 13840/10 and Addenda 1 and 2, relating to the draft Regulation on Short Selling and certain aspects of Credit Default Swaps, and No. 7379/11, relating to the corresponding Opinion of the European Central Bank; and supports the Government’s position that proposals should not impact market efficiency and liquidity, in particular in relation to sovereign debt.—(Mr Hoban.)
The Minister did not say whether we would have another parliamentary opportunity to revisit this matter following an ECOFIN agreement. Setting that aside, however, the disclosure requirements in such a regime, or in one that we might want to pursue in the UK, would be a positive step forward. The Government have said that anything that improves the disclosure regime would be a step in the right direction. We want market transparency because that would help to counteract some suspicions about dysfunctional or distorting speculative activities.
Similarly, I think there is common ground between the Opposition and Government on any reserve powers that regulators need to intervene in adverse circumstances as a circuit-breaker when frenetic speculation might take place. Quite clearly, we were right to suspend the short selling arrangements in 2008 for those reasons. The particular point for me is the question of uncovered and naked short selling, and I suppose it would be easier if I put that in more transparent terms.
Naked short selling is essentially taking insurance against an asset when one does not have ownership of or a stake in that asset. It would be the equivalent of me taking out insurance on your car, Miss McIntosh. You might be happy for me to do that, but it would give me an incentive to wish for dreadful things to happen to your car, such as it running into a tree. Perhaps I might torch your car late at night. If such a thing happened, the fact that you would then have to have your car replaced would be to my personal financial benefit, which would clearly be an odd, dysfunctional market arrangement. In a similar way, many of the people who have been anxious about naked short selling have been worried that their assets are essentially targeted for abusive behaviour.
I accept that there is a market abuse regulation in place that, in theory, is supposed to outlaw the abusive trashing or bad-mouthing of other people’s assets. In practice, however, the real motivation that my hon. Friend the Member for Luton North was asking about—where the concerns about naked short selling are coming from—arises due to the suspicion that there is a distortive effect of the market that can adversely and unfairly affect the price of an asset. The Minister is right to say that the evidential basis is never that clear, but that is because finding causation in such circumstances is almost impossible. There are various correlative effects that one could trace. If most people were asked whether market sentiment was affected by the price of credit default swaps in respect of an asset, their intuitive answer would be yes, but finding the QED point is quite difficult.
I hope that at some point—perhaps not in this Committee—we can have a more sensible discussion about the pros and cons of uncovered short selling. I accept that many investors use the process to obtain a generalised offset for their investment exposure to a particular country and that if they could not use that particular device, they would either have to use an alternative device, or the price of bonds might be driven higher still. I accept that there are two sides to this argument, but I am a bit uncomfortable with the impression that I am getting from the Minister that the Treasury just wants to brush this particular issue aside as though it does not merit significant attention. We should not dismiss it merely because it comes up as part of a
I suspect that the negotiations have a long way to go, and I agree that we need an evidential basis if we go ahead with any reforms. Rather than being in pure resist mode, however, I hope that the Treasury—perhaps showing the spirit of the Secretary of State for Health towards his reforms—will be in learning and listening mode. Just because there is absence of evidence, it does not mean that there is evidence of absence. We need to reserve our judgment on this issue until we see the shape of the final regulation following the ECOFIN meeting, as well as until we have had a chance to debate properly the pros and cons of naked short selling.
As much as I was impressed by the Minister’s delivery, I am not convinced by the benefits of a completely liberal market in short-term instruments of this kind and of such gambling. In addition, I am not convinced that the process is beneficial to trade in the genuine sense, but equally I am not convinced that it is damaging—I have yet to hear a convincing argument one way or another. If the Minister says that the process is not damaging, what is the motivation of countries such as France and Germany that are pushing so hard for regulation? I am still in the dark about to that. I understand that the view is that we should abstain on the motion—I will certainly do so—but I wait to be convinced that such financial activity is beneficial. I still have a suspicion that it is damaging and that it has had some malign role in what has happened to Greece, Ireland and Portugal. I will leave it there, but I have to say that I remain a sceptic.
Mr Hoban: I shall not prolong our short and helpful debate unnecessarily, but I want to respond to a couple of issues that were raised by the hon. Members for Nottingham East and for Luton North. The hon. Member for Luton North reflects on the comments made by the hon. Member for Nottingham East on anxiety about naked short selling without an evidence base, which gives us a sense of the argument about such a ban. There is anxiety that speculators are undermining sovereign debt in the same way in which speculators undermined shares in financial services businesses at the peak of the financial crisis. The challenge is to demonstrate that there is evidence to show that that is the case.
This is not the first time that we have rehearsed such issues. Indeed, we did so with only a marginally different cast list when the Bill that became the Financial Services Act 2010 was debated in the previous Parliament. At that time, powers to ban short selling were put on a legislative footing by the previous Government with our support. We had an extensive discussion about different types of short selling, including naked short selling and short selling when the stock had been borrowed. The conclusion of the evidence presented by the FSA, which
I apologise for not responding to the question on scrutiny. By virtue of this debate, the scrutiny reserve will be lifted, so the matter will not return to Parliament for further discussion. There is a more complex mechanism when there is a transfer of powers under the European Union Bill, which the other place is debating today, but this is the only opportunity that the House has for debate.
When I was in the shoes of the hon. Member for Nottingham East, I found it frustrating that quite significant changes to European regulations that had a direct impact on London and the UK were subject to little parliamentary scrutiny. In fact, parliamentary scrutiny was a tip of the iceberg in the context of general debate. I particularly felt that during the debate on the markets in financial instruments directive which, because I pushed my luck a bit with the now shadow Chancellor, lasted well over an hour and half. However, that was a fraction of the time that the Commission, the European Parliament and the Council had spent on the directive, so the hon. Member for Nottingham East makes an important point.
There is an intensive exchange of views between the Treasury and the European Scrutiny Committee on these issues. I write regularly to my hon. Friend the Member for Stone (Mr Cash) and the noble Lord Roper, who chairs the comparable Committee in the House of Lords, to keep their Committees up to date with where we are at. That has been particularly the case on the regulation that we are discussing, on which both Committees have showed a great deal of interest and have sought to engage.
Chris Leslie: I know that this is a minor point of procedure, but it would be awfully helpful if the Minister would provide copies of such correspondence and exchanges to the Opposition in the future, because otherwise we find out about them only when the papers are compiled, which can be close to the date of a particular debate.
Mr Hoban: The hon. Gentleman should be careful what he wishes for on such things, given that the flow of correspondence may be quite significant and on a range of measures—from the mundane to the exceptionally important. However, I will reflect on what he has said.
I want to touch on hon. Gentleman’s point about transparency. He is right to signify that the Government are supportive of that. I believe that transparency in the financial markets is quite an important discipline. Participants in financial markets are given greater confidence about the markets’ integrity if they understand what positions people hold, so it will be worth spending some time referring to it.
Disclosure and transparency are important contributors to efficient and stable markets. We believe that enhanced transparency through the disclosure of net short positions in shares balances the need to retain short selling as a legitimate and positive market activity with the need
This is not a name-and-shame approach. There is a clear, non-stigmatising precedent in disclosure requirements for major shareholders—those who hold long positions, as they are described—and we are not persuaded by arguments that individual public position disclosure will have any long-term adverse impacts on market quality in terms of increased volatility or reduced liquidity.
This returns to the point about evidence. There is a case for taking the disclosure approach when it comes to the short selling of shares. However, the same cannot
I am grateful for the opportunity to discuss the measure that the European Scrutiny Committee has given us. The regulation is important, and I am grateful for the input from hon. Members, which will help to inform our negotiating position as we move towards reaching a general approach, hopefully at the May ECOFIN.
|©Parliamentary copyright||Prepared 6th April 2011|