Markets in Financial Instruments
The Committee consisted of the following Members:
Alison Groves, Sarah Heath, Committee Clerks
† attended the Committee
The following also attended, pursuant to Standing Order No. 119.6:
Markets in Financial Instruments
Stephen Phillips (Sleaford and North Hykeham) (Con): It is a pleasure, as always, to serve under your chairmanship, Dr McCrea. It might—or indeed might not—be helpful to the Committee if I took a few moments to explain the background to the documents and the reason why, as long ago as 31 October, the European Scrutiny Committee recommended them for debate.
The markets in financial instruments directive came into force in November 2007, replacing the investment services directive. A core pillar of EU financial markets integration, MIFID set the legal framework and conduct of business requirements that apply to firms providing investment services—such as brokerage, advice, dealing, portfolio management and underwriting—in financial instruments, and the conditions governing the operation of trading venues, such as regulated markets. It established the powers and duties of national competent authorities in relation to the regulation of such activities and included rules to protect investors.
In October 2011, the European Commission proposed replacing the existing framework directive with a regulation and a new directive. The draft regulation would set out requirements in relation to the disclosure of trade transparency data to the public and transaction data to competent authorities; removing barriers to non-discriminatory access to clearing facilities; the mandatory trading of derivatives on organised venues; specific supervisory actions regarding financial instruments and positions in derivatives; and the provision of services by third-country firms without a branch.
The draft directive would amend specific requirements regarding the provision of investment services, the scope of exemptions from the current directive, organisational and conduct of business requirements for investment firms, organisational requirements for trading venues, the authorisation and ongoing obligations applicable to providers of data services, the powers available to competent authorities, and sanctions and rules applicable to third-country firms operating via a branch.
The European Scrutiny Committee recommended the documents for debate because, at the time, the Government were unable to assure us that they would definitely be able to secure some necessary improvements to the texts before they were adopted by the Council. I hope to hear from the Minister today that such improvements have been or will be secured.
The Financial Secretary to the Treasury (Greg Clark): It is a pleasure to serve under your chairmanship, Dr McCrea. The markets in financial instruments directive, as my hon. and learned Friend the Member for Sleaford and North Hykeham said, is an important piece of legislation, which, since coming into force in 2007, has played a significant role in strengthening the single market in financial services. The goal of the original directive was to improve the competitiveness of EU financial markets by creating a single market for investment services and activities, while ensuring a uniform standard of protection for investors in financial instruments such as shares, bonds, derivatives and various structured products.
I will recap briefly some of the specific measures in the original directive. It introduced competition to traditional exchanges, breaking up the national monopolies that had existed before. That competition has succeeded in reducing the prices charged by trading venues, making it cheaper for investors to trade. It introduced an EU-wide transparency regime for equity markets, which has increased the efficiency of such markets. It strengthened the rules for passporting investment services, which has helped to remove barriers that existed in the single market for financial services. It also set out uniform rules governing the provision of investment services to clients. In particular, it mandated that investment firms must provide their clients with the best price available.
Those measures have had a profound effect on the landscape of financial markets. There are now far fewer barriers to cross-border trade in financial services. The introduction of competitors to traditional exchanges has increased choice and driven down costs for investors.
Andrea Leadsom (South Northamptonshire) (Con): Will the Minister advise us on whether the introduction of the financial transactions tax under the enhanced co-operation by some member states will be affected by the introduction of MIFID II? The duty on brokers and dealers to generate the best transaction costs for their customers may lead them to transact outside the countries that have introduced the FTT.
The Chair: Order. Can I just say that questions are not asked of the Minister in his opening remarks? We will come immediately to questions to the Minister afterwards, but I appreciate the hon. Lady’s intention.
There are now far fewer barriers to cross-border trade in financial services. The introduction of competitors to traditional exchanges has increased choice and driven down costs, which has benefited the real economy. According to a report commissioned by the City of London corporation, the cumulative impact of MIFID I has been an overall gross domestic product gain of 0.8% in the EU. Most commentators, and indeed the Government, agree that MIFID I has been a great success.
I turn to the purposes of the review of the directive. Although the general picture of MIFID I is of legislation that has met its objectives, it has nevertheless brought
In the years since MIFID I was implemented there have also been considerable changes, as we know, in how financial markets function. The second objective of the review was therefore to address those changes and put in place new regulatory measures to ensure the stability and integrity of markets in response to technological change.
The final objective of the review was to address issues exposed by the financial crisis. At the G20 summit in Pittsburgh in September 2009, global leaders committed to take action to regulate over-the-counter derivatives markets. The G20 agreed to several measures to improve the risk mitigation and transparency of OTC derivatives, including that:
Several of those measures, including the clearing obligation, have been implemented in the EU through the European market infrastructure regulation. However, the final part of the G20 commitment—to ensure that all standardised and liquid derivatives are traded on organised trading platforms—will be implemented through the MIFID review.
Beneath those broad objectives, the Commission has made a number of important policy proposals. I will run briefly through some of the main policy issues and outline the Government’s continuing negotiating objectives in those important areas. As my hon. Friend the Member for South Northamptonshire said, these are live discussions and agreement on them has not yet been reached.
The first issue is the Commission’s proposal to introduce a new category of trading venue called the organised trading facility. Some trading venues operate business models that mean that they are currently outside the scope of MIFID. They include broker crossing networks, which match buy and sell orders electronically without revealing pre-trade prices. As they perform the same function as many multilateral trading facilities, but without conforming to the same regulatory rules, that has created an unlevel playing field. We therefore support the Commission’s objective in the MIFID proposal to bring broker crossing networks into its scope.
The new category also covers the non-equity markets, in which it aims to offer a more flexible venue for derivatives that are subject to the G20 trading obligation. On that point, the Government agree that is important to create that new venue category to ensure that the widest possible range of OTC derivatives can be moved safely to trading on organised venues.
The next Commission proposal on MIFID is to extend the rules on market transparency, which under MIFID I covered only equities. They should now cover non-equities too, and the Government support that initiative. Greater transparency helps to protect investors and generally leads to greater efficiency in price formation. However, we believe that a careful approach is needed
In response to technological changes, the Commission has proposed new rules governing the operation of high-frequency trading. The Government believe that it is important that appropriate measures are introduced to mitigate the risk of high-frequency trading strategies inadvertently causing another flash crash, as it was known. However, we believe that care is needed in the calibration of regulatory measures to ensure that the benefits that high-frequency trading brings to the market through increased liquidity are not lost.
The final proposal concerning market structure is the new regulatory category of the small and medium-sized enterprise growth market, which is designed to provide for a more proportionate regulatory regime for SME stocks centred around the venues on which they trade. The Government warmly welcome that measure and believe that it is an important first step towards both reducing the burdens on SMEs and stimulating cross-border investment in SMEs across the EU.
The Commission has proposed new rules for the regulation of commodity derivatives. There are particular challenges to ensuring the orderly functioning of commodity derivative markets, namely the risk of short squeezes, which occur when the buying interest in a futures contract exceeds the available supply in the underlying commodity itself. Futures sellers, faced with the prospect of not being able to deliver the commodity when the contract expires, are forced to buy back the contracts rapidly, which in turn can force prices to artificially high levels. To combat the threat of short squeezes, the Government believe that market operators and regulators should have a suite of tools available to them, known as position management tools, to ensure appropriate action can be taken to prevent such a situation from occurring. We believe that the Commission has placed undue emphasis on position limits in its proposals. We continue to make the case for the position management regime as the better solution.
The Commission proposes to build on the competitive measures brought about by MIFID I by introducing a policy of open access between trading venues and clearing houses. The Government warmly support that measure. For too long, vertical monopolies have existed between exchanges and clearing houses. That was highlighted as long ago as 2001 in the Commission’s Giovannini report. The Government believe that the measure will remove an important obstacle to competition, helping to create a more competitive single market in clearing and trading services.
The Commission has also proposed harmonising the rules under which investment services can be provided by non-EU firms into the EU, through the establishment of a so-called third-country regime. Although the Government believe that there would be economic benefits to extending the freedoms of the single market to third-country firms, our prime objective is to ensure that the UK remains open to trade in financial services
Finally, the Commission proposes to strengthen the rules concerning investor protection, notably by banning the payment of inducements connected to so-called independent financial advice. That is a similar measure, though narrower, to that recently introduced in the UK under the Financial Services Authority’s retail distribution review. The Government support measures to tackle the problems of mis-selling and welcome the Commission’s initiative to establish a higher regulatory standard at the EU level. However, recognising the considerable pressure from other member states not to go that far, the Government’s main objective in the remaining discussions is to ensure that the UK is still able to implement tougher measures domestically as required.
On balance, the Government welcome the proposals of the MIFID review and believe that they will help build on the success of MIFID I in furthering the development of the single market in financial services. However, the success of the legislation will be determined to a great degree by the technical details, which is why it is still being discussed. We therefore continue to negotiate carefully to ensure that the final legislation provides an appropriate regulatory basis for the provision of financial services in the EU, while ensuring that the regulation continues to support competition and choice for the users of financial services and thereby promotes growth in the real economy.
I will conclude by giving the Committee a short update on where we have got to in the negotiations, which will respond to my hon. Friend the Member for South Northamptonshire’s point. The Committee will be aware that we initially planned to hold this debate prior to ECOFIN in December last year, as the Cypriot presidency had indicated that it planned to move for a political agreement in the Council at that time. Unfortunately, the presidency was unable to proceed due to continuing outstanding differences in the Council. Since then, the Irish presidency has made some progress, but issues remain unresolved, and the presidency does not yet feel able to proceed to ECOFIN, so this is not something that is going to be agreed or decided in the coming days. Our current expectation is that it will try to seek political agreement in the second quarter of this year.
The main areas of difference concern the transparency measures and the open access policy. Regarding transparency, France and a number of other member states are pushing for a uniform standard of transparency across all venues. Although the UK very much supports increased transparency, we believe in a calibrated approach, and we will not accept measures that result in unnecessary additional costs for the users of financial services and therefore for the real economy.
Finally, regarding open access, Germany and a group of member states are pushing for the removal of the Commission’s proposed open access policy. The UK is strongly in favour of the open access measures, which we see as being at the heart of ensuring a competitive
The Chair: We now have until 3.30 pm for questions to the Minister. May I remind Members that those questions should be brief? It is open to a Member, subject to my discretion, to ask related supplementary questions. I call Chris Leslie.
I want to ask the Minister about transparency, which he mentioned in his concluding remarks. By the time I got to page 688 of the document, I noticed that one of the Government’s negotiating objectives was greater clarification on the transparency requirements that will be applied, so that liquidity and costs of funding are not adversely affected. The Minister talked about how he was worried about pre-trading transparency propositions, and said that we needed a calibrated approach—one of those phrases that I am always intrigued about—and that he did not want additional costs.
Surely it is positive that regulated venues for trading must make public the current bid and offer prices and the depth of trading interest at those prices for particular instruments. Why are waivers needed for that pre-trade transparency? Will the Minister clarify that?
Greg Clark: Yes, I am happy to do that. The hon. Gentleman is right. In general, we want transparency. That is important and can contribute to our competitive objectives. There are, as he would acknowledge, some markets in which the level of liquidity and the volume of trades is sufficiently low that the depth of the market does not enable us to have that degree of transparency without revealing the underlying positions of the parties and without shining light on the balance sheets or trading positions of the people in that market.
Generally, we want trading done through a market wherever that is possible, but in some illiquid trades it is more akin to a negotiation of prices between two sides. As with any negotiation, one can understand that if there is total transparency either before or after, the possibility of that negotiation is diminished, which could lead to people exiting the market and not being able to offer important services. That calibration is important.
It is a subtle point, but in the final discussions of these dossiers, it is important that we preserve points that may seem subtle and technical to this Committee and the House but could nevertheless make a big difference to consumers.
Chris Leslie: I am grateful for the Minister’s response. It sounds like that is much more a marginal issue than one that would resist transparency requirements more broadly. However, more information on how he is defining that calibrated approach would be useful.
My second question is about the central counterparty clearing processes and post-trade arrangements that the directive and the regulations make changes to. Will the
Greg Clark: The hon. Gentleman is right to raise this issue, which is one of the most egregious examples of acting against the spirit of the single market, which is so important to this country and to every consumer across the EU. We take that extremely seriously. The hon. Gentleman alluded to the legal challenge that we have launched against the basis of the decision that has been taken, which we are pursuing with the European Court of Justice. I do not have any further information on the progress of that matter to offer the Committee, but I undertake to keep the hon. Gentleman in his official capacity, and the Committee and the Opposition, up to date about developments in Court hearings.
Andrea Leadsom: Will the Minister advise the Committee whether the financial transactions tax achieved under enhanced co-operation will have an impact on brokers’ ability to do business in the countries in question, bearing in mind that the rules of MIFID require them to provide the most effective execution possible, which presumably has regard to the cost of doing the transaction?
Greg Clark: My hon. Friend makes an extremely important point. We reserved our position in the ECOFIN on the financial transactions tax proceeding under enhanced co-operation, and recorded our concerns in a minutes statement. One of the reasons why we did so was that we did not think sufficient attention and consideration had been given to these potential extra-territorial effects. As my hon. Friend knows, the proposed initiative has just been published. We are looking at it very carefully to make that assessment. It is one of a number of concerns we want to see addressed. I am sure that this Committee in particular will take a close interest in scrutinising the proposal, which has just been published, and for which an explanatory memorandum will be supplied in due course.
That the Committee takes note of European Union Documents No. 15938/11, a draft Regulation on markets in financial instruments and amending Regulation [EMIR] on OTC derivatives, central counterparties and trade repositories, and No. 15939/11 and Addenda 1 and 2, a draft Directive on markets in financial instruments repealing Directive 2004/39/EC; notes the importance to the UK economy of stable and well functioning financial markets; and welcomes efforts to improve transparency, while supporting competition and user choice, as part of the global post-crisis regulatory reform agenda [18th Report of Session 2012-13, HC 86-xviii, Chapter 2].
I hope I have covered the contents of the debate in my opening remarks, describing the history of the proposals and where we are in the negotiations. I hope the Committee will be content for that to serve as my introductory speech for this debate.
Chris Leslie: We also can see merit in updating the MIFID arrangements, but there is clearly an overlap with the wider regulation of financial services. Obviously, we have been discussing this for quite some time and no doubt we will continue to do so, certainly for another year or two, I should imagine. It is important to recognise the role of the European Union in some of these particular questions, but I worry sometimes that on some of these questions we are driven by EU policy rather than necessarily being in the driving seat ourselves.
Hopefully the draft regulations will improve issues such as the disclosure of trade transparency data to the market, and also to the regulatory authorities more broadly. The Minister may recall that I tabled a series of amendments to what is now the Financial Services Act 2012. When it came to data availability for regulators, there was some resistance from the Government to ensuring that there was a modern data collection capability within—as it will now be—the Bank of England to keep track of markets with considerable volumes at very high frequency and high volatility, so that regulators are able to discern trends and keep an eye on what is happening in the markets at large.
The Dodd-Frank reforms—or part of them—have actually found their way into enactment in the United States. The Americans created the Office for Financial Research, which was part of a device to ensure they have 21st-century data collection capabilities that reflect the modern nature of those markets. I am still concerned that while we gave general permission to the Bank of England to do what it needs to, in a regulatory context, we have not necessarily encouraged it more broadly to take up those tools to match some of those modern facets of the market. If we are to make this notion of prudential regulation a reality, we must ensure that the eagle-eye view is able to drill down into the data, if indeed it is required to do so. That is one of my concerns about the set of rules we have. It does not necessarily relate to this particular European approach, but I think we should take the opportunity when it arises.
Another specific point I wanted to touch on is the issue of commodities derivatives. I did not raise a question about this, but I think it is quite important. I welcome the Government’s support for a new regime to prevent market abuse of commodities derivatives. However, I am surprised that the Government are a bit more set against harder position limits approaches, and about the exemptions for firms using commodity derivatives that they are seeking in the negotiating arrangements. The Minister says that the Government want to take a position management tools approach, because there is undue emphasis on position limits in the proposals so far. When he responds to this debate, I would like him to discuss those particular issues.
About 15 years ago, some £300 million of commodities trading took place in the UK, whereas now that has increased by about 1,000%. Billions and billions of
If there is market abuse and manipulation, it can have a serious impact on real lives. That is why it is important that, when we see so many giant corporations with very deep pockets so often being accused of distorting markets and purchasing whole monthly futures contracts, potentially hurting consumers in poorer countries, we should take the opportunity to ask whether we have the right market abuse arrangements in place and, if not, whether we could make changes and improvements. If companies were cornering the market in equities or listed shares, that would trigger regulatory action, but when large corporations corner the market in commodities that seemingly does not trigger regulatory action. That is a bizarre anomaly and we need to modernise the arrangements.
At a very basic level, we have got to have much more transparency, to see what is being bought and when, and serious consideration should be given to learning from the American reforms, whereby they have a cap on the positions that single firms are able to take on commodities options. I think that the cap is around 25% of total trade volume, and that seems a not unreasonable proposition for the Government to consider.
Consequently, there are opportunities here for the Government to take more of a proactive policy lead with this European agenda. The commodities derivatives issue is just one facet of that. This particular set of negotiations in Europe is a very long and winding road, but I would be grateful if the Minister could respond particularly on the data collection issues for regulators and the commodity market reforms.
Andrea Leadsom: Following on from what the hon. Member for Bristol North West was just saying, I too am concerned that since the financial crisis there have been a number of measures and directives—in fact, I believe there have been 49—coming out of the EU that all seek in some way to limit the financial services market, whereas prior to the financial crisis a lot of new measures and directives were driven from the UK, with a view to completing the single market and to opening up and making more uniform and more equitable the different financial markets. I share the hon. Gentleman’s concern that—potentially— because the EU is now doing something to shut things down, actually in some ways some of the things that it is attempting to do are focusing on the wrong things. The issue of commodity prices is a fair one, particularly regarding the impact of over-speculation on food prices.
However, I recall that in one of the first sessions of the Treasury Committee in 2010 I asked the Governor of the Bank of England what he thought about the fact that there was $1.4 quadrillion of derivatives outstanding
I do not want to be alarmist, but it seems to me that simply to say, “Right, from now on all derivatives must be traded on recognised exchanges”, does not go nearly far enough to recognise the massive expansion in the search for profit of the investment banking industry. I urge the Government to use the opportunities given by issues such as MIFID II coming to the table. In my mind, it offers no more than a meagre sticking plaster and, unfortunately, often in the wrong areas; I cite the issue of maximum capital for banks within the EU where Britain argued that we should not be restricted to a cap on the maximum capital that we could require banks to have. It is important that we can raise capital levels even higher if we believe that the British economy is in risk of another banking crisis.
The same is particularly true of derivatives trading and it is shocking that the EU is focusing on trying to steal our business by suggesting that, somehow, it would be safer if euro-denominated derivatives were traded in the eurozone. I remember putting to a German embassy member that that was tantamount to us saying that if BMW build a lot of Minis in Oxfordshire, it would have to relocate to Britain. It is of that ilk: utterly meaningless, pointless and never going to happen. On the other hand, no attempt is being made to ensure that we are not somehow getting ourselves into a position where the entire financial sector could be destroyed at one stroke by a collapse in the derivatives sector.
I throw that thought out there because the EU proposals are often in the wrong area and focused on the wrong things; they are trying to shut the door after the horse has bolted and not looking at where the next problems will come from. In many ways, there is an unnecessary fear of trying to constrain financial sector growth. There are certain areas where financial services are incredibly valuable, but in areas such as high-frequency trading and over-the-counter derivatives trading, their absolute size is a massive concern and a massive risk for the world economy.
Greg Clark: Let me respond to the speeches made by my hon. Friend the Member for South Northamptonshire and the hon. Member for Nottingham East. First, we should acknowledge, as I said in my introductory remarks, that the experience of MIFID to date, in terms of MIFID I, has been positive for the UK. It has extended possibilities to UK firms and it has been to the benefit of UK consumers as well as those across Europe. It is an area of EU regulation where if it is got right, we can benefit from it.
The whole purpose of our discussions, and one of the reasons why the discussions are still ongoing, is that we are insistent that we will not take an airy, high-level view; we will engage in the detail and, in particular, the nuances that affect our interests. Indeed, we find that in many circumstances we are speaking up for other European
My hon. Friend is absolutely right that, in this country in particular, given the strength and importance of the financial sector in terms of the size of the economy, we have a particular exposure to the consequences if things go wrong. That is why in some areas we are arguing for flexibility to enable us to safeguard the interests of UK taxpayers and consumers. We will continue to press for that.
To address some of the other points made, the hon. Gentleman is absolutely right that information for regulators is important. It is also important that there should continue to be a lively debate in regulatory practice to keep in step with, and preferably ahead of, the practices of the financial markets. Those markets are well known to be creative and constantly changing, and it would be unconscionable if the regulatory system were slower or less fleet of foot than market operators. It is a constant challenge for regulators to be able to anticipate future needs and to have the information that they need. One of the benefits of transparency is that information is available to regulators as well as to market participants. That is why we are strongly in favour of this proposal.
Our record of being at the cutting edge of regulatory research and practice is establishing itself and attracting international respect. I have met with Sir John Beddington, the chief scientific adviser, who is leading a Foresight study into high-frequency trading. He brought together participants and experts—academics and practitioners—for the purpose of making sure we understand the potential systemic consequences of high-frequency trading, and know what information and tools regulators require to manage them. The report that the project issued was presented in this House, and it has been presented internationally. My discussions with our counterparts and colleagues in the United States and on the continent show that there is a great deal of interest in the research that is being conducted by Foresight. If we are to be a beacon of excellence in financial services, as I intend us to be, that is a good example of the way in which we should be conducting research into best regulatory practice.
The hon. Gentleman raised the issue of commodity derivatives, which are important for end consumers. It is important that that issue is illustrated by evidence.
One of the reasons that we should have a judicious approach is that liquidity in commodity markets can be an important means of dampening otherwise volatile price movements, which might be the result of seasonal conditions in agriculture. It can signal to farmers and growers around the world where investment is needed in future years to solve shortages. It is important that we do not, for reasons that might be well intentioned, create problems that are worse than those we are solving.
That is why our position on commodities, in terms of position limits, favours a position management approach. Our approach must include powers to set position limits, but they must be deployed flexibly when they are needed. If a problem is detected, based on the information that the hon. Gentleman rightly said should be available, position limits can be imposed or taken off as appropriate. Position management is not an alternative to position limits; one must include the other. It is representative of the importance we attach to the flexibility to be fleet of foot. We know that a rigid regulatory regime that is not able to respond to market events can lead to problems of the kind that my hon. Friend the Member for South Northamptonshire referred to. That is why we continue to favour a strategy that includes a greater variety of management tools.
The discussions will continue. Depending on the progress of the legislation before the Council, the Committee might want to take another look at MIFID if material changes are made. The progress that has been made over recent months has narrowed down the areas of primary concern. We still have some way to go, but I hope that Members feel that this debate has shone some light on those important issues, and that they are better informed about the state of negotiations.