Select Committee on European Union Forty-Fifth Report


What remains to be done?

51. Many witnesses have confirmed at various times during the course of this inquiry that the critical outstanding Directives are the Investment Services Directive, the Directive on transparency obligations for securities issuers - the "Transparency Directive", the Prospectus Directive (has since completed the Level 1 process, so it is no longer outstanding), the Capital Adequacy Directive[31] and the Takeover Directive[32].

52. The Commission has yet to bring forward its Capital Adequacy Directive, (in her evidence, the Financial Secretary to the Treasury suggested that this Directive did not form part of the FSAP[33] [Q. 499]), the new compromise on the Takeover Directive, a new Directive on Corporate Governance or the new Company Law Directive amending the 10th and 14th Company Law Directives. Most attention has, therefore, been focussed on the Investment Services Directive. This is because it is regarded as the "centrepiece of the FSAP" [Q. 524].

Investment Services Directive

53. A major concern for the UK has been to preserve the compromise reached in the European Parliament's first reading debate. In particular, Article 25 would allow major investment banks to continue to do business direct without having to use the local stock exchanges. The Committee visited Brussels the day that the Council (ECOFIN) voted to amend Article 25 by ten votes for and five against. The latter included the United Kingdom, Ireland, Luxembourg, Sweden and Finland. The dissenters included the largest equity capital market in Europe (the UK) covering about 40% of all EU business and the largest debt markets (UK and Luxembourg). This was a marked change from the normal way in which matters of this importance have been dealt with at ECOFIN [Q. 374]; it is rather as though the Agricultural Council had forced a vote on the European wine industry in the teeth of opposition from France, Spain, Portugal, Italy and Greece!

54. It is alleged that the Council amendment introduces covert protectionism by requiring investors to use exchanges by making obstacles to competition from investment banks sufficiently onerous as to dissuade them from doing off-exchange business as they currently do in London. In effect, the amendment reintroduces the pre-trade transparency requirement that was lost in the Commission proposal abolishing concentration rules [Q. 495]. Inevitably, this will raise costs. The Chief Secretary to the Treasury estimated the potential loss through less competitive pricing for institutional clients might be as much as around £300 million a year. A recent report[34] also suggested a similar figure of potential loss for institutional clients and questioned the true extent of off-exchange trading. The Financial Secretary wished to see the Council amendment to Article 25 reversed, although she noted that there had been important benefits secured through the ISD as it currently stood [Q495]. One witness thought that costs would be quite substantial [Q. 374]. Among the reasons said to have been given by the Presidency for proceeding to a vote on this occasion before a "common position" had been reached, was the need for the preliminary linguistic and juridical work to be put in hand in order to meet the spring 2004 deadline.

55. The Treasury Minister believed that much could still change between now and the adoption of the Directive [Q498], although other witnesses expressed doubt on that point [Q.374, 375 and 397] [35]. The Committee regrets that an issue of some importance was decided in ECOFIN by Qualified Majority Vote (QMV) in the face of opposition from important financial centres and urges the Government to make every effort to ensure that an acceptable outcome be reached.

Capital Adequacy Directive

56. In its evidence, Association of Private Client Investment Managers and Stockbrokers (APCIMS) writes: "a financial company that falls within the Investment Services Directive also falls within the Capital Adequacy Directive which designates the amount of capital that a firm has to hold if it is to be allowed to operate. The amount of capital varies from type of firm to type of firm and is substantial"[36]. The Capital Adequacy Directive is now being revised (and also renamed as the Risk-Based Regulatory Capital Directive) to accommodate changes affected by the Basel II negotiations[37].[38] (see Box 3). The Basel Committee is proposing to change the way internationally active banks assess risks and apply capital according to these risks. The European Commission proposes to take that work and apply it to every firm that falls within the Investment Services Directive (ISD). According to APCIMS, studies to date have shown that this could result in huge increases for investment firms wholly disproportionate to the amount of risks that they run. Other witnesses have observed[39]:

"without substantial modification in European rules to take account of the risk profile of investment business, EU firms would need to hold significantly more regulatory capital than non-EU banks with a similar risk profile outside the EU, putting them" [i.e. the non-EU banks] "at a major competitive advantage".

57. The European Commission has still to bring forward the revised Directive. Dr Schaub, recognising that there had been concern, said that,

"the Commission is technically ready for the necessary steps to be launched next spring" [Q. 313]".

Box 3
The Basel 2 Accord on Capital Adequacy

The Accord covers proposals for new requirements that improve banks' stability by tying their capital more closely to the risk of their assets.

The new accord's proposals are divided into three pillars:

1. minimum capital requirements;

2. supervisory review of capital adequacy and

3. public disclosure.

First Pillar: Minimum capital requirements:

The accord proposes:

  • a new measure for calculating risk-weighted assets to provide improved bank assessments of risks and to make capital ratios more meaningful.
  • introduces three distinct options for calculating credit risk and three others for operational risk to avoid a one-size fits all approach.
  • introduces a requirement for explicit treatment of operational risk making the bank's capital ratio more reliable.

Second Pillar: Supervisory Review:

The second pillar of the new accord is based on a series of guiding principles for

  • banks to assess their capital adequacy positions relative to their overall risks; and
  • for supervisors to review and take appropriate actions in response to those assessments.

If there is a capital shortfall, supervisors may for example require a bank to reduce its risks so that existing capital resources are available to cover its minimum requirements.

Third Pillar: Market Discipline

The third pillar proposes a set of disclosure requirements that allow market participants to assess key information about a bank's risk profile and level of capitalisation. The New Accord places strong reliance on banks' internal methodologies which gives them greater discretion in determining their capital needs

Transparency Directive

58. One element in this Directive in particular has caused concern in London, namely the requirement for companies to make quarterly reports to the market.

"The main issue with quarterly reporting is the need to ensure that companies announce material changes to the market. In the UK, this is a requirement placed upon companies right now in that they have to report immediately any information that is material to the share price. Such a requirement is not present in most European countries" [which have] "a phraseology about reporting to the market in terms such as "as soon as possible". The real concern, therefore, is that a transparency obligation that will improve reporting in some countries would actually reduce reporting in the UK"[40].

59. In fact, the obligation to report to the market is present in other European countries but is not practiced and enforced in the same way as it is in the UK. The real issue is a cultural one - the UK is used to reporting price sensitive information speedily whereas continental Europe is not.

60. APCIMS adds:

"it needs to be noted that such reporting cannot be done without proper auditing as no company could afford to make a financial statement of this sort unless the numbers had been independently checked"[41].

61. We find this proposition questionable. Auditors do some sort of a review which might vary from private reporting to the Board of Directors to a formal review-style opinion which could be published. The point is that public reporting would require companies to prepare information to public reporting standards (with or without auditing) and to spend time communicating the results to the market (shareholders and analysts). There is also the question of liability which we address in paragraph XX below.

62. The Chairman of Euronext argued that when companies got used to it, quarterly reporting was not necessarily as onerous as feared and he did not accept that a requirement on companies to submit quarterly reports would lead to volatility and "short-terminism" or even accounting errors simply because people had to comply [Q. 478-479].

63. For the Commission, Dr Schaub said

"personally I believe that this is not a topic which requires a particular religious conviction. For me, it is typically a topic where we can live with diversity and see how the conviction within this integrated market will develop" [Q. 313].

64. The Committee found this to be a sensible approach. Mandatory quarterly reporting would not increase transparency in those markets where companies directed a regular flow of information to the markets but would increase costs. Quarterly reporting, however, would increase transparency in those markets where reporting was not currently frequent. The obvious solution should be for a requirement for flexibility so that Member States could choose quarterly reporting or UK-type practice where existing national practice did not already require frequent reporting to the market. The objective of the Directive, after all, is transparency.


65. One witness identified a potential problem that could arise from the Transparency Directive as it is currently drafted. Mr Lachlan Burn, a partner at Linklaters, introduced supplementary evidence covering this single point. He argued that:

"the draft Transparency Directive ("the Directive") significantly extends the established limitation in English case law on the civil liability of directors and auditors arising from the publication of a company's annual accounts and audit report. As a result, if implemented in its current form, the Directive would mean that directors and auditors would not only be liable to shareholders (as is presently the case) for any errors in the published financial information, but that they would also be liable to the general public. This substantial amendment to the current position on civil liability under English law is contrary to the Commission's stated intention that the Directive should not have such an effect in Member States".

66. Mr Burn's supplementary evidence goes into considerable detail on this point. The Committee were not in a position to take a view but when we spoke to the Director-General of the DG Internal Market, Dr Schaub admitted that it was not a point that had been raised to date [Q. 317]. Dr Schaub asked Baroness Cohen of Pimlico, a Member of our Committee who is also a non-Executive Director of the London Stock Exchange,

"is it your impression that the rules, as they are at present discussed in the Council and Parliament, would increase the degree of liability?"

67. Baroness Cohen answered that, she believed they did [Q. 318]:

"at the moment doctrine and practice are fairly clear in England. We are responsible to shareholders and only incidentally to the wider market, the people who can sue you - which, as a lawyer, is where I always look - are your shareholders. It looks as if the category of people who can sue you is being widened to anybody who might be a potential shareholder - to investors generally".

68. The Commission have yet to comment on Mr Lachlan Burn's supplementary evidence. The Committee considers that it is important that the text of this Directive be clarified so that the degree of potential liability may be accurately identified. We therefore urge the Government to establish with the Commission the extent to which the liability of directors and auditors might be increased as a result of this Directive. If Mr Burn's interpretation of the effect of this Directive is confirmed, we wish to know how the Government will respond.

Takeover Directive

69. The Community has been struggling to agree a Takeover Directive for over 22 years. The last attempt failed in the European Parliament on 4 July 2001[42]. A further attempt failed in the Competitiveness Council on 19 May 2003. The Committee raised this issue with the Chair of the European Parliament, Economic and Monetary Affairs Committee, Dr Christa Randzio-Plath, who said:

"I am very sorry I cannot give you a guarantee that at the end we will have a Directive but I can give you the impression that there is a positive approach to try to find reasonable compromises".

70. Asked what the sticking points were, Dr Randzio-Plath said,

"the problems that you have are that you have the different cultures of the shareholders" [Q. 307-308].

71. Part of the European Parliament's difficulty lay in deciding where responsibility resided. Dr Randzio-Plath explained:

"we deal with this Directive in three different Committees …… the Social Affairs Committee insists on the rights of the employees, there is also support in the Economic Affairs Committee. We do not know what the Legal Affairs Committee is doing" [Q. 304-308].

72. For the Commission, Dr Schaub said:

"we believe that we need a Directive which eliminates at least some of the more unreasonable obstacles to cross-border takeovers" [Q. 313].

73. The two most difficult aspects of the Takeover Directive relate to articles 9 and 11. Article 9 proposes a ban on directors taking frustrating action, such as issuing new shares to a friendly party, when in receipt of a hostile bid. Article 11 would seek to override differential voting rights when an acquirer has more than 75% of the risk bearing capital of the target company. In this context, readers are invited to refer to the Committee's Report[43] published in June 2003 in which we examined the extent to which the potential advantages that the draft Directive would make available to UK companies/investors outweighed the potential disadvantages and the risk of increased litigation in the UK. The Government's Response sets out the Government's position in detail[44].

74. The Committee did not explore the nature of the new Portuguese compromise on the draft Directive nor whether it might succeed in attracting a majority in the European Parliament. Our concern was to determine how the failure to adopt this Directive within the deadline might seriously affect the FSAP. The Treasury witnesses believed that it would not [Q 499].

75. It will be important for the capital markets that a level playing field in the regulation of takeovers emerges. The lack of an agreement on the Takeover Directive by the April 2004 deadline would not in itself seriously affect the ability of the EU to make progress with the other elements of the Financial Services Action Plan but such a failure could weaken the movement towards the efficient and effective operation of a single market in capital including that in existing companies. However, key provisions in the proposed Directive should not be diluted. There is, as we have said before[45], a clear UK interest in the Directive improving the position in other Member States, and in particular opening up markets for UK companies and making more secure the position of UK investors in Europe.

31   Written evidence from BBA - Page 24, written evidence from Barclays Bank - Page 48, written evidence from ACPIMS -Pages 173 and 174, written evidence from IMA - Page 202, written evidence from LIBA - Pages 14 and 15, written evidence from FESE - Page 110, written evidence from ICAEW - Page 199, written evidence from FSA - Page 58, written evidence from ProShare - Page 34, written evidence from Stephen Revell - Page 215, written evidence from HM Treasury - Page 159 and written evidence from Euronext - Page 133. Back

32   The Committee has reported earlier on EU Takeover legislation - "Takeover Bids" - 13th Report, 95-96, HL Paper 100 and "If at first you don't succeed …… Takeover Bids Again". 28th Report, 2002-03, HL Paper 128. Back

33   The Basel Committee's findings will be transposed into an EU Directive - Capital Adequacy Directive 3. The Basle timetable has slipped, so the timetable for CAD3 will too. Current target is that this Directive will be implemented by the end of 2006. Back

34   The Potential Impacts of ISD2, Article 25" - OC & C Consultants, August 2003. Back

35   See "Where next for the ISD" by Theresa Villiers, MEP, the Parliament Magazine, 3 November 2003 Back

36   Written evidence from APCIMS - Page 173. Back

37   See the article by the Chairman of the Basel II Committee, the Governor of the Bank of Spain - Financial Times, 30 October 2003. Back

38   See the fears expressed by EUROCHAMBRES about implementing costs especially for SMEs - EU Reporter (27-31 October 2003). Back

39   Written evidence from LIBA - Page 14. Back

40   Written evidence from APCIMS - Page 174. Back

41   Written evidence from APCIMS - Pages 173 and 174. Back

42   The Parliamentary vote split 273-273, but the vote was lost because of 22 abstentions. For a Directive to be passed, it must have a majority over those against and any abstentions - European Information Service (06/07/2001). Back

43   "If at first you don't succeed …… Takeover bids again". 28th Report, Session 2002-03, HL Paper 128, Paragraph 80. Back

44   Government Response. Back

45   "If at first you don't succeed …… Takeover bids again". 28th Report, Session 2002-03, HL Paper 128, Paragraph 80. Back

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