1 Financial services
| (31956)
13840/10
COM(10) 482
+ ADDs 1-2
| Draft Regulation on short selling and certain aspects of credit default swaps
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| Legal base | Article 114 TFEU; co-decision; QMV
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| Department | HM Treasury
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| Basis of consideration | Minister's letter of 1 March 2011
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| Previous Committee Reports | HC 428-iv (2010-11), chapter 3 (20 October 2010) and HC 428-ix (2010-11), chapter 8 (24 November 2010)
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| Discussion in Council | 15 March 2011
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| Committee's assessment | Politically important
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| Committee's decision | For debate in European Committee B
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Background
1.1 The Commission held a four week public consultation on short
selling,[1] during June
and July 2010, following both 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.[2]
In September 2010, with this draft Regulation, the Commission
proposed introduction of a number of permanent measures, as well
as some temporary measures to be employed in adverse circumstances,
in relation to the short selling of financial instruments.
1.2 When we considered this proposal, in October
2010, we noted that it was clear that the Government had, with
good reason, considerable reservations about it, reservations
which we shared. However before considering the document further,
which we thought we were likely in due course to recommend for
debate, we asked to hear from the Government about:
- discussion of the draft Regulation
in the Council working group, particularly in relation to the
Charter of Fundamental Rights, to the potential for fiscal consequences
of European Securities and Markets Authority interventions in
sovereign debt markets, to the lack of an evidence base for the
proposal and to the unquantified cost of the risks being addressed;
and
- representations made to the Government by UK
stakeholders.
1.3 In November 2010 we were told that, during Council
working group discussions:
- in relation to the Charter
of Fundamental Rights, several Member States had noted that certain
provisions under the proposal might give rise to issues under
Article 17 (right to property), specifically those proposals which
would give competent authorities (and the European Securities
and Markets Authority) the power to prevent natural or legal persons
from entering into transactions relating to financial instruments
in certain circumstances;
- a number of Member States, including the UK,
had raised concerns that the Commission proposals extended to
sovereign debt and that the European Securities and Markets Authority
would have powers to intervene in sovereign debt markets —
this was on the basis that such measures could increase volatility
and impair the liquidity of sovereign debt markets and thereby
impair the ability of governments to easily raise funds and increase
the costs of raising funds;
- in response, the Commission and the Presidency
had requested written representation from Member States on the
fiscal implications of the proposals as they related to sovereign
debt; and
- a number of Member States had also raised the
issue of the lack of evidence to justify the Commission's proposal,
in particular as it related to sovereign debt, and to the unquantified
cost of the risks being assessed — the Presidency had acknowledged
that these issues need to be considered very carefully.
1.4 We also heard that the issue of sovereign debt
had been discussed at the 25 October 2010 meeting of the Economic
and Financial Committee's Sub-Committee on Bonds and Bills by
Member States' debt management authorities — most interventions
on this matter questioned the need for and the efficacy of the
proposed Regulation with regards to sovereign debt markets.
1.5 As for representations the UK industry has made
to the Government, we were told of various meetings by the Treasury
and the Financial Services Authority with interested parties,
and that:
- the meetings set out the timing
of the negotiations and possible next steps, followed by detailed
discussion around the key issues of sovereign debt, the European
Securities and Markets Authority, the restrictions around naked
short selling, the marking regime and buy-in and fines for late
settlement, with even more discussion with the Gilt Edged Market
Makers (GEMMs) on the implications for sovereign debt;
- the industry was very supportive of the Government's
position and it had a helpful discussion around the wording of
the primary market exemption;
- the industry has also made direct representations
to the Commission on the issues; and
- the Treasury was working closely with the Debt
Management Office and the GEMMs to strengthen the Government's
position in its representations to the Commission and
the Presidency.
1.6 We said that we looked forward to hearing in
due course about further progress in the negotiations. We added
that at that stage we might wish to recommend the debate we had
previously foreshadowed. But meanwhile the document remained under
scrutiny.[3]
The Minister's letter of 1 March
1.7 The Finance Secretary to the Treasury (Mr Mark
Hoban) reports that:
- there have now been seven negotiating
meetings on the proposal;
- the Presidency is aiming to table the proposal
at COREPER on 9 March 2010; and
- it is aiming to seek a general approach at the
15 March 2010 ECOFIN Council.
The Minister then addresses the questions we have
asked about the Charter of Fundamental Rights, the sovereign debt
market, European Securities and Markets Authority powers, the
lack of an evidence base for the proposal and the question of
unquantified risks attaching to the proposal.
1.8 On the Charter of Fundamental Rights the Minister
says that:
- the requirement for public
disclosure of significant net positions in shares remains —
as noted previously this may in some cases engage rights under
Article 7 of the Charter, by requiring disclosure of personal
information;
- Article 7 has the same scope as Article 8 of
the European Convention of Human rights;
- the right to respect for private life is not
absolute but qualified — a public authority may impose a
restriction on it where the restriction is in accordance with
the law and necessary in a democratic society in the interests,
inter alia, of the economic well-being of the country;
- the Government position is that the requirement
for public disclosure does satisfy these conditions — it
strikes the correct balance between providing a degree of restraint
on excessive and potentially disruptive short selling, but does
not deter legitimate and beneficial short selling;
- the most recent Presidency text proposes a modification
of the powers in Articles 17(3) and 24(1)(d) of the draft Regulation
for national competent authorities and for the European Securities
and Markets Authority respectively to prevent persons from entering
into transactions;
- under the revised draft this power may only be
exercised in order to prevent a disorderly decline in the price
of the financial instrument;
- the use of this power may engage Article 17 of
the Charter, if, for example, it is used to prevent a person from
disposing of their lawfully acquired possessions (whether this
right would be engaged would depend on the nature of the transaction
which is forbidden); and
- Article 17, however, is not an absolute right
— the use of property may be regulated by law insofar as
is necessary for the general interest.
1.9 In relation to sovereign debt the Minister tells
us that:
- inclusion of measures to restrict
the short selling of sovereign debt and credit default swaps has
generated significant discussion in the Council working groups;
- the Government has continued to argue strongly
for the removal of all references to sovereign debt from the proposal,
on the basis that there is a lack of evidence to support the assertion
that short selling of sovereign debt or sovereign credit default
swaps has played a significant part in the recent financial crisis;
- the Commission's credit default swaps taskforce
report,[4] which was recently
released to the public, did not support the need for regulation
in this area;
- officials have produced evidence to support Government
views and highlighted the likely detrimental effect of the proposals
on the ability of Member States to raise sovereign debt —
for example, a joint HM Treasury and UK Debt Management Office
paper was circulated to the Council; and
- a number of other Member States have supported
the removal of sovereign debt from the scope of the proposed Regulation.
1.10 Turning to the powers of the European Securities
and Markets Authority the Minister says that:
- the Government's aim has been
to ensure that powers given to the European Securities and Markets
Authority go no further than agreed in the regulatory and supervisory
package, which created, inter alia, the authority, and
that such powers must be exercised legally in accordance with
the Meroni[5] principle;
- the Government is continuing to raise concerns
about the extent of the European Securities and Markets Authority's
powers in the current Commission proposals, particularly with
regards to discretionary decisions that may be taken by the authority;
- it is therefore continuing to propose the deletion
of Article 24 (on the authority's intervention powers), thereby
limiting the authority's role to one of co-ordination in relation
to measures taken by competent authorities — however, there
is little support for this approach from other Member States;
- in the Meroni case the Court of Justice
made clear that EU institutions may delegate powers to independent
executive or regulatory bodies only if the delegation relates
to clearly defined executive competences, meaning that no power
for making policy choices may be granted to the delegated body;
- the delegated powers cannot consist of "a
discretionary power implying a wide margin of discretion"
— Article 24 of the draft Regulation, which gives the European
Securities and Markets Authority the power temporarily to prohibit
or restrict certain financial activities, allows such a wide discretion
that it is difficult to reconcile the provision with Meroni;
- concerns remain around Article 24 giving the
European Securities and Markets Authority power to choose both
the measures to be taken, and to whom those measures are to be
applied — there are currently no criteria to determine how
that choice is to be made or how the authority is supposed to
judge the effectiveness of measures taken by Member States;
- however, a number of Member States are keen to
give a significant role to the European Securities and Markets
Authority; and
- the Government will continue to work with the
Commission, Presidency and other Member States to secure a final
text which confers only those powers that may lawfully be conferred
on the European Securities and Markets Authority.
1.11 On an evidence base for the draft Regulation
the Minister tells us that:
- many of the key proposals still
lack a convincing evidence base and the Government remains concerned
by the extent to which Member States are asked to produce evidence
to support their points of view;
- the Government believes an ideal starting point
should be the Commission providing evidence to support the need
for proposals; and
- as noted before the Government has taken every
opportunity to provide evidence to support its arguments, including
the paper on the proposal's effect on fiscal policy and sovereign
debt.
1.12 As for unquantified risks the Minister says
that:
- the Government has expressed
concern to the Commission that its impact assessment does not
quantify costs of the risks being addressed;
- specifically, the cost/benefit analysis is incomplete,
in that figures are given only for the disclosure elements of
the proposed short selling regime;
- in addition, those disclosure calculations are
based largely on estimates — for example, for sovereign
bond exposure, where disclosure is made solely to national regulators,
the Commission's expectations for the UK market are above £47
million for transition costs and above £5 million per annum
on an ongoing basis; and
- no further costs are available for the other
(non-disclosure) measures proposed although these will be substantial,
particularly for a flagging regime.
The Minister adds that the draft Regulation lacks
a clear evidence base and rigorous impact assessment and that
the absence of such analysis and compelling evidence is an increasing
concern in relation to Commission proposals. He suggests that
we might wish to consider how we could work with other national
parliaments to highlight the importance of evidence-based regulation
to the Commission, particularly in the context of the number of
proposals due to be published in the coming months.
1.13 The Minister also gives us a brief update on
engagement with UK industry stakeholders, saying that:
- the Government is working in
close co-operation with the Financial Services Authority;
- officials have also continued to consult with
industry trade bodies and firms on a regular basis, holding their
most recent consultative group meeting on 26 January 2011; and
- the industry is entirely supportive of the positions
taken by the Government on all the key issues in the draft Regulation.
1.14 The Minister also tells us about two issues
on the draft Regulation where a successful conclusion appears
likely. First, in relation to marking, he says that:
- originally the Commission proposed
that all short sales should be flagged on electronic trading venues;
- the Government took the view that this was an
unnecessary additional cost to business as there would be an overlap
with the disclosure regime;
- it is now in a position where the majority of
Member States support the deletion of the marking provisions;
and
- the Presidency and the Commission have acknowledged
the consensus in the Council and have deleted the relevant article
from the text.
Secondly, in relation to buy-in and settlement, the
Minister says that:
- under this proposal trading
venues would be required to buy-in financial instruments where
there was a failure to settle trades;
- there would also be a fine for late settlement;
- the Government contends that buy-in requirements
are unnecessary, on the basis that there is no evidence that short
selling is a major cause of settlement failure;
- if a provision is justified, it is the Government's
view that it would be best dealt with in a horizontal measure
in a proposal of wider application, such as the proposed Central
Securities Depository legislation or the proposed Securities Law
Directive; and
- this view is supported by the majority of Member
States.
Conclusion
1.15 We are grateful to the Minister for his latest
account of developments on this draft Regulation. However we note
that a successful outcome on sovereign debt and the powers of
the European Securities and Markets Authority seems as yet uncertain.
Moreover we are concerned that the Commission continues to fail
to produce an evidence base for proposals in the draft Regulation
and a proper cost-benefit analysis.
1.16 So we think the Presidency wish to secure
a general approach on the matter at the ECOFIN Council on 15 March
2011 is wholly unjustified — a rushed conclusion would inevitably
result in poor legislation. Moreover, as we have said before,
there is a significant risk that Article 24 is unlawful in that
it delegates too much power to the European Securities and Markets
Authority, in breach of the Meroni principle. However much
Member States want this agency to have a powerful role, the confines
of EU law must be respected; otherwise the resulting legislation
will be vulnerable to a legal challenge. It follows therefore
that rather than clearing this document from scrutiny, we recommend
that it be debated in European Committee B, so that Members can
examine these contentious matters.
1.17 If the Government thinks it possible that
sufficient progress may be made on improving the text of the draft
Regulation as to allow it to support a general approach on 15
March 2011 the debate would, of course, have to take place before
then.
1.18 As for the Minister's suggestion about national
parliaments collectively emphasising to the Commission the importance
of evidence-based regulation we will explore this possibility
with other members of COSAC (Conference of Community and European
Affairs Committees of Parliaments of the European Union).
1 The practice of selling assets that have been borrowed
from a third party with the intention of buying identical assets
back at a later date to return to the lender and with the hope
of profiting from a decline in the price of the assets between
the sale and the repurchase. Back
2
A sovereign credit default swap is a contract in which one party
pays a fee to another party in return for compensation or payment
in the event of the sovereign experiencing a specified credit
event (such as where a sovereign repudiates or declares a moratorium
on paying its debt). Back
3
See headnote. Back
4
See http://docs.google.com/viewer?a=v&q=cache:BbNTU1n6Y7sJ:online.wsj.com/public/resources/documents/
ReportonsovereignCDS12072010.pdf+Report+on+Sovereign+CDS&hl=en&gl=uk&pid=bl&a
mp;srcid=ADGEESgh_fhd7NdLFXp4fUyHT0XCMjYUCdlP7a1oxNy8knRW1wZ3hhKegd1Bj7muRnAPsQ3s
5A7Uan56b9L-z5nGFCbUOSMJBy1jnWbGu6S-rvNkW--B7SPe_f49V36TtQQ_DjeVqkUT&sig=AHIEtb
TDY88_QQ6tLGrilasUI-hAyA4Rzg.
Back
5
Case 9/56, Meroni & Co, Industrie Metallurgische SpA v
High Authority [1958] ECR 133. Back
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