Select Committee on European Union Forty-Ninth Report


Letter from the Minister, Ruth Kelly, to the Chairman

  Sub-Committee A considered your Explanatory Memorandum on the above document on 21 January. The Sub-Committee was grateful to you for the information provided including the indication that the proposal might be agreed during the Italian Presidency later this year.

  The Sub-Committee decided to hold the document under scrutiny. We would be grateful if you could give the Committee a full account of the Government's extensive consultation to which the Explanatory Memorandum refers, including a summary of the responses received. Such information will greatly assist the Committee in future consideration of this proposal. I look forward to your early reply.

22 January 2003

Letter from the Minister, Ruth Kelly, to the Chairman

  I submitted an Explanatory Memorandum (14796/02) to Parliament on the proposed EC Directive on investment services and regulated markets (COM (2002) 625) on 9 December 2002. In response, your Committee requested further information on the Government's consultation processes and also a summary of the views of interested parties about the proposal.


  The Treasury works closely with the financial sector and other stakeholders in developing its approach to EC financial services legislation. On important directives, including the Investment Services Directive (ISD), it is normal practice to:

    —  put in place joint project teams with the Financial Services Authority, the Bank of England and UKRep (and sometimes other departments such as the DTI);

    —  set up a formal consultation group ("roundtables") with industry on the proposed legislation, ideally before a formal proposal is made by the Commission. The ISD roundtable met formally three times in 2002—each involving over 30 organisations. A further roundtable meeting has been scheduled for February, to which over 50 organisations have been invited;

    —  set up one or more small, tightly focused "drafting groups"-comprising experts from financial institutions, trade associations, City law firms and the Financial Services Authority. The objective of these groups is to consider in detail the Commission's proposed Directive-and subsequent Presidency texts-with a view to proposing drafting changes to achieve the Government's policy goals. Such groups proved extremely effective in the negotiation of the Prospectus Directive. In the case of the ISD, the Treasury has set up three separate drafting groups considering different aspects of the Directive;

    —  use smaller, ad hoc groups of industry contacts when necessary to address strategy towards particular issues;

    —  participate in private sector conferences and seminars. On the ISD, this has included at least three events in the first few weeks of 2003;

    —  engage in bilateral discussions with financial institutions, including bringing directives such as the ISD to the attention of senior executives and others during more general, strategic discussions; and

    —  participate in EU-level consultation and discussion arrangements. The Commission has held two open hearings on the ISD, each of which was attended by 150-200 people.

  The Treasury has had direct contacts with over 50 organisations about the ISD through these and other routes.


  Few industry participants have formally publicised their views on the proposal but it would appear that the overall feeling of the industry is one of qualified support. The proposal is generally seen as containing many positive aspects. Some market participants, however, are concerned. There are some specific areas where important reservations have been expressed. In general, these views accord with those of the Treasury, as outlined in the earlier Explanatory Memorandum.

  In summary, the industry generally welcomes:

    —  the move towards country of origin regulation, which is seen as a robust approach to creating a single market in investment services;

    —  the abolition of the concentration rule; and

    —  the robust post-trade transparency regime. The limitation to equity transactions is generally seen as welcome.

  However, concerns expressed by the industry include:

    —  the possible impact of the proposed conduct of business rules on "execution only" and direct offer business. The general preference is for retail customers to be able to continue trading on an execution-only basis where they have no wish for investment advice;

    —  the general view of the client order handling rules is that if there is a strong "best execution" rule protecting retail customers there is no justification for either the "default rule" or the "limit order handling rule". In particular, the default rule is generally seen as inappropriately implying that on-exchange execution is best-and therefore effectively reintroduces the concentration rule;

    —  the general view is that the mandatory quote disclosure rule is at best unnecessary and at worst totally unworkable. The concern is that the rule risks reducing liquidity and market efficiency, leading to worse outcomes for investors and that it could put EU markets at a serious competitive disadvantage compared to major markets elsewhere in the world. The general preference is for the rule to be removed in its entirety;

    —  the restriction of access to regulated markets to eligible counterparties is generally seen as unjustified and potentially very damaging to EU markets as it would make it harder for them to gain more business. Furthermore, the ability of home state regulators—rather than the regulator where the business is being transacted—to determine whether or not a firm qualifies as an eligible counterparty is generally seen as inappropriate;

    —  the general feeling about the definition of "professional investor" is that the threshold for large companies and other institutional investors to be classified as professionals (and, hence, being relieved of certain inappropriate investor protection measures) is too high;

    —  the effect on market participants of the inclusion of commodity derivatives within the scope of the Directive—in particular, the potential application of disproportionate capital requirements; and

    —  whilst appropriate convergence of rules is generally seen as desirable and necessary for the creation of a single market in investment services, there is concern that harmonisation at too detailed a level—through mandatory Level 2 measures—may well disadvantage investors by disrupting well-functioning markets. The preference is for more regulatory convergence via Level 3, through permissive (not mandatory) comitology provisions.

  I hope that this summary of the views of interested parties will enable your Committee to properly consider this important document. If you should require any further information in order to clear the document, please let me know.

29 January 2003

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