Financial Regulation: a preliminary consideration of the Government's proposals - Treasury Contents

Written evidence submitted by Plus Markets Group Plc

  1.  I am the Director of Regulation of Plus Markets plc, a Recognised Investment Exchange based in the City of London operating both primary and secondary market infrastructure. In addition to operating a Regulated Market for listings, PLUS maintains the PLUS-quoted market a primary market for unlisted securities which is the second largest growth market within Europe, and competes in trading services against traditional Exchanges and MTFs with 7,500 UK and European securities on its platform. We operate in a space characterised by rapid evolution of market regulation, technology and user preferences. As an operator of market infrastructure with a core franchise of helping companies raise funds and providing trading and investor services, PLUS has an understandable interest in the proposals set out in HM Treasury's consultation "A new approach to financial regulation: judgement, focus and stability" and are grateful for the opportunity to make known our views.


  2.  We are supportive of the need for reform albeit reform which should go further and not merely be limited to structural change. The revised regulatory architecture must be well placed to identify and mitigate prudential and systematic threats to the integrity of the system. With this in mind, we concur in that the perspective of a central bank is needed and the Bank of England should given a more operational role with both responsibility for financial stability and a full array of macro-prudential supervisory tools. It is our view that responsibility for stability and macro-prudential supervision must go hand in hand with the micro-prudential supervision of individual firms to enable the Bank to enable deliver on the overarching objective of financial stability: this aspect of the proposed regulatory architecture is likely to be well received at an EU level. These proposed reforms are justified in our estimation on the basis that the supervision of prudential risk must benefit from better comprehension and understanding of developments and cyclical imbalances within the financial system. That said, whilst the Bank of England is more likely to be in a position to make use of a judgement-focused supervisory approach, it remains to be seen how well the Bank will operate in a heavy duty operational and rules based environment. As an RIE we do not have a sufficiently direct interest in prudential regulation and will therefore refrain from substantial comment on the range of macro-prudential tools proposed to be made available to the Bank of England. However there is a danger that the impact of the prerogatives afforded the Bank of England may become overbearing unless its supervision benefits from a robust and workable mechanism whereby the Bank of England is accountable. At the same time there are tensions inherent in the proposed regulatory framework not least when it comes to accountability and cooperation between respective regulatory authorities.

  3.  Our chief concern is to ensure that the significance of market infrastructure is correctly appreciated and we have identified characteristics of the proposed regulatory architecture which merit further consideration by HM Treasury. Future initiatives relating to Exchanges and market operators are likely to recognise that their proper role in promoting confidence, transparency, price formation, equal access and liquidity and in the mitigation of idiosyncratic risks posed by innovated exchange-traded products are likely to be greater in the scheme of things than the need to protect consumers. The protection of consumers is important but it is by no means the dominant factor in play when it comes to the supervision and regulation of financial markets and stock exchange activity. At the same time, the UK needs to understand that the needs of wholesale and retail markets are different and need to be approached in different ways and whilst financial stability and the integrity of financial markets ought to be the sole objective, supervision needs to keep pace with and not stifle innovation. We have particular concerns over the proposed future of the UK Listing Authority and also proposed reforms concerning Recognised Bodies and seek for these proposals to be withdrawn.


  4.  We take comfort from the proposals outlined in the consultation paper relating to the FPC's role in supervising and monitoring the performance of the PRA and the CPMA. Significant cooperation between both will prove necessary and to ensure that their respective agendas are harmonised and calibrated towards ensuring financial stability. In particular the FPC's power to give directions may prove particularly useful when it comes to ensuring that the PRA and CPMA are correctly aligned and that their respective agendas benefit from the perspective of the central bank and its monetary policy. The proposals with respect to CEOs of the PRA and CPMA being members of the FPC and being appointed to each other's respective Board may go some way to achieving this and to fostering a culture of cooperation but the two bodies. However, the PRA and CPMA are likely to have very different cultures with the likelihood that a number of tensions inherent in this architecture may exist. The potential for competing agendas is acute given the different cultures but added to the tensions inherent in the proposed regulatory architecture on a national level, there also exists the possibility for competition in agenda and remit as between the domestic regulatory authorities and the new supra-European regulators due to be brought into being next year. Duplication of output and dialogue are likely to be troubling features requiring a lot of regulatory engagement as between regulatory bodies and participants in the financial services system on a number of levels. It could be that HM Treasury's proposed regulatory architecture is influenced by considerations of European oversight and in particular the demarcation of responsibility between the European Banking Authority and the European Securities and Markets Authority. Whilst there is evidently a well perceived need for national regulatory authorities to engage and cooperate with these supra-European supervisors, a replication of this divide on a national level poses potentially very serious difficulties surrounding the engagement of individual firms with the PRA and the CPMA.

  5.  The impact will be felt by Exchanges and market operators, leading to a position where Exchanges and market operators providing both trading and clearing services will be supervised by both the PRA and the CPMA (dual supervision). This concern is especially pertinent at the present time given that the London Stock Exchange is believed to be in discussions with a number of banks with a view to establishing and operating a clearing house.[6] There is an increasing trend within the EU of Exchanges moving into the provision of clearing services (Euronext and NYSE LIFFE for example). The EU is proposing to develop regulatory initiatives designed to mitigate risk with the involvement of both Exchanges and clearing facilities as it perceives both as useful mechanisms to dampen the risk within the financial system associated with the trading of derivative securities OTC.[7] Although the considered response to these initiatives appears to have dissuaded the EU from making use of exchange infrastructure in this way,[8] there are obvious synergies and approaches involving both Exchanges and clearing facilities. Nevertheless, central counterparties providing clearing services will be supervised by the PRA whilst Exchanges and market operators will be supervised by the CPMA in the new regulatory landscape. The effect of HM Treasury's proposals are far reaching though and it should be recognised that even CCPs solely providing clearing services may be supervised by the CPMA as regards conduct of business. Dual supervision involves additional burden, cost and resource for a broad range of different business models and there exists the possibility of intrusive conflicting supervisory agendas impacting a single firm.


  6.  It remains to be seen how the PRA will be resourced to discharge its micro-prudential supervisory responsibility and ensure that its front line supervisory functions are equipped to undertake a judgements-focused supervisory approach as opposed to utilising a "check-box" approach. This danger is of particular concern when it comes to the CPMA based on our experience of the FSA. The make-up of the CPMA needs to be adequate to take responsibility for supervision of firms' conduct of business and for policy concerning the conduct of business and markets infrastructure, as operationally distinct from its consumer protection function. That poor standards of behaviour and risks to consumer protection often involve securities traded on Exchanges and other market infrastructure is not sufficient justification in our view for the CPMA supervising market infrastructure in addition to those firms that are in the business of trading securities. In order to justify the CPMA supervising Exchanges and market operators, the CPMA will need to be resourced and well positioned to formulate and progress key policy initiatives relating to markets that recognise their proper role in promoting access to markets, confidence, transparency, price formation and liquidity.

  7.  In terms of firms' conduct of business and the relationship between the regulation of conduct of business and financial markets, retail activity and investment are significant both in terms of maintaining markets as viable venues for capital raising and in terms of facilitating secondary market liquidity. CESR has quite rightly perceived that volumes of trading in equities and wholesale bargain sizes are diminishing since the introduction of MiFID in late 2007.[9] In this environment and in the context of reduced appetite for investment, retail activity and retail trades become of greater significance as do their interaction and combination with wholesale activity and investment. This needs to be recognised by the CPMA whose agenda and approach should appreciate the significance of retail activity rather than being skewed towards acting in a fashion that tends against it for consumer protection reasons. This is especially true with regard to the regulation of retail client advisory business in that whilst the CPMA should be an incisive tool to hold to account and prevent unethical behaviour on the part of financial services professions it should not pursue an overbearing approach when it comes to regulating the conduct of advisory business. The significance of markets as mechanisms for raising capital and for fuelling economic growth and recovery needs to be borne in mind. The proposed removal of the UK Listing Authority from the CPMA to reside with the Department for Business, Innovation and Skills rather runs the risk of the regulation of firm's conduct of business not benefiting from this awareness and perspective.

  8.  Foreseeable regulatory initiatives for Exchanges and market operators in the medium term (predominantly originating from the EU) include the CESR Review of MiFID and the likely impending EU directive amending MiFID,[10] the extension of the pre- and post- transparency obligation, the implementation of proposals to counter the adverse effects of fragmentation of liquidity, micro-structural issues concerning high frequency trading, sponsored and unsponsored Direct Market Access, trading platform stability, also pricing, best execution, the trading of OTC derivatives on-exchange, short selling, the review of the Prospectus Directive[11] and listing and disclosure requirements for UCITS, and the recognition of foreign non-IFRS issuer financial reporting. The CPMA needs to be sufficiently dexterous to be able to take into account the evolution of markets infrastructure, trading practices and user need in the formulation of regulatory policy and approach to EU representation, and legislation. The CPMA must additionally have regard to the distinct needs of the wholesale and retail markets in addition to those of consumers.


  9.  It is our view that the CPMA's credibility may be hampered ab initio by the removal of the UK Listing Authority from the CPMA to reside under the Department for Business, Innovation and Skills. We foresee particular difficulties when it comes to UK representation and engagement with the new European Securities and Markets Authority because the CPMA will not have responsibility for the Listing function. Most of the central plans underpinning the UK's Listing framework have their origin in European legislation and the UK is exposed to the possibility of regulatory intervention from the EU that undermines the pedigree of listing on the UK's Official List and threaten the UK's competitiveness—witness the evolution of the recently introduced Standard Segment. The Listing function is of considerable importance in maintaining the UK as a credible and competitive destination for listings and therefore needs to be ensconced within the CPMA and benefit from the CPMA's accountability and its norms for interacting with the financial services industry, the EU and the European Securities and Markets Authority. It also should be recognised that there is also cross-over with the consumer protection brief given that within the Listing Rules there are specific rules legislating for consumer protection such as those relating to closed ended investment companies, investment trusts, REITs and UCITS. The interests of consumers and investors are paramount when it comes to framing rules and policy relating to prospectuses, class transactions, circulars, disclosure, transparency and financial reporting: seen in this way, there is more of a synergy between primary markets and the CPMA's remit for the regulation of conduct of business and consumer protection as compared to the CPMA's role in the regulation and development of secondary market infrastructure. Why then separate the UK Listing Authority from the CPMA? Deprived of the listing function, it becomes harder in our view to justify responsibility for the supervision of Exchanges and market operators falling within the CPMA's purview. If the proposals in the consultation are to be legislated into being without substantial alteration, our recommendation would nevertheless be that the UK Listing Authority should remain with the CPMA.

  10.  With regard to the proposed merger of the UK Listing Authority with the Financial Reporting Council (FRC), the FRC has a role in promoting confidence in capital markets. The FRC plays a part in monitoring and ensuring that that corporate governance is sound, that financial reporting is of sufficient quality and more particularly, that the narrative of directors' reports properly reflects and accounts for the risks and uncertainties specific to a particular business. Of particular concern in relation to smaller companies is the appropriateness of sensitivity analysis and the impact of certain sensitivities on working capital and the FRC's role in these areas is supportive of improving the quality of behaviour on capital markets. There is some overlap here with the remit of the UK Listing Authority, however such a merger if carried into effect would greatly expand the function of the Listing Authority and take it into other areas. The Listing Authority's present remit expands beyond issuers applying for inclusion or included in the Official List (given the effect of the Prospectus Directive) however there is significant doubt in our mind as to reason for the merger proposal which needs to be carefully examined and the rationale for the changes made out. In particular, there is a danger that to merge the UK Listing Authority with the new companies regulator will prove too burdensome to issuers listed or seeking to list on the Official List and will undermine London's competitiveness. There is little to suggest that merging the FRC and the UK Listing Authority would enhance their respective functions.


  11.  The EU has discerned increasing unease with Multilateral Trading Facilities ("MTFs") which are subject to less stringent regulatory requirements than Regulated Markets at the present time. With this in mind, CESR is proposing changes to ensure that the requirements for MTFs are made more stringent to align the requirements more closely to those to which operators of Regulated Markets are subject.[12] As the operator of a Regulated Market subject to more burdensome requirements PLUS is supportive of the arrangements with respect to firms authorised by the UK as operators of MTFs being looked at and made more robust. Regulatory requirements to which a Recognised Body or authorised firm are subject should be determined by reference to the activities carried out rather than the regulatory status of the operator. That said, we would resist an attempt to remove or erode the status accorded Recognised Bodies in the regulatory system, not least because this would be out of step with the European Union which recognises the distinction between operators of Regulated Markets and MTFs. The distinction and status of a Recognised Investment Exchange remains valid given that as operators of Regulated Markets, they bear responsibility for primary markets and compete as listing destinations against their counterparts within the EU. The organisational and regulatory requirements and resources are different compared to those required to maintain pure secondary market infrastructure. This is the case to a greater extent in that both of the UK's RIE equity markets, the London Stock Exchange plc and PLUS Markets plc also operate exchange-regulated primary markets (AIM and the PLUS-quoted market), therefore the regulatory requirements and risks associated with these market infrastructures are wholly different compared to those authorised firms operating as MTFs which are pure trading facilities for trading securities listed on EU exchanges. Looked at in this way, there is every reason to maintain separate regimes. RIEs bear a unique position within the regulatory landscape because of their role in the price formation process as operators of primary markets. RIEs are quasi-regulatory bodies and benefit from this status in superintending the activities of exchange member firms and from the statutory information sharing gateways and prerogatives afforded them. To seek to remove or erode the status of a Recognised Body would be counterproductive and HM Treasury needs to make out a case for conflating the two regimes as there is little evidence to suggest that the different requirements are problematic. As the operator of a Regulated Market we fully concur with the need to accept a higher degree of regulatory burden and the requirements in Part 18 as a Recognised Investment Exchange.

21 September 2010

6   Reported by City AM on 20 September 2010. Back

7   Committee of European Securities Regulators ("CESR") consultation paper, Standardisation and exchange trading of OTC derivatives July 2010. Back

8   See the Proposal for a Regulation of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories COM (2010) 484/5. Back

9   Committee of European Securities Regulators ("CESR") consultation paper, Technical Advice for the European Commission in the Context of the MiFID Review-Equity Markets April 2010. Back

10   Markets in Financial Instruments Directive 2004/39/EC. Back

11   EU Prospectus Directive 2003/71/EC. Back

12   Committee of European Securities Regulators ("CESR") consultation paper, Technical Advice for the European Commission in the Context of the MiFID Review-Equity Markets April 2010. Back

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