EUC Report: MiFID II

Lord Harrison Excerpts

Tuesday 26th March 2013 Grand Committee

Moved by

[Lord Harrison]

That the Grand Committee takes note of the Report of the European Union Committee on MiFID II: Getting it Right for the City and EU Financial Services Industry (2nd Report, HL Paper 28).

[Lord Harrison]

My Lords, I am delighted to have the opportunity to introduce this debate on the report of the European Union Committee entitled MiFID II: Getting it Right for the City and EU Financial Services Industry. This report was based on work undertaken by the Sub-Committee on Economic and Financial Affairs, which I have the honour to chair. The report was published in July 2012, and was based on evidence received from a number of practitioners and experts in the operation of financial markets. The committee was also assisted in its work by Professor lain MacNeil, Alexander Stone Chair of Commercial Law at the University of Glasgow, who acted as specialist adviser for the inquiry. I thank him and all the witnesses who contributed so richly to this report.

This proposal for a directive and regulation on markets in financial instruments is a complex legislative package, as our seven-page glossary indicates, but it is also extremely important. The original MiFID package, which came into effect in November 2007, is the foundation of the EU regulatory framework for investment firms. These firms encompass a wide range of activity such as global investment banks trading complex securities, fund managers investing pension funds, stock-broking firms and small high street financial advisers providing financial advice to the general public. The Commission’s objectives were to open up trading in securities to competition, to apply equivalent regulatory rules to different market models which perform similar functions and to enhance, standardise and harmonise investor protection across the European Union.

The new proposal, known as MiFID II, seeks to respond to deficiencies in the MiFID I regime exposed by the recent financial crisis. It focuses in particular on addressing problems that have arisen from the expansion in over-the-counter (OTC) trading, including the transparency of such trading. It seeks to shift trading from the more opaque OTC market to more transparent organised markets, in line with the September 2009 G20 commitment to tackle the less regulated and more opaque parts of the financial system by the end of 2012.

The committee’s starting point was to ask whether a review of MiFID I was even necessary. We found that it was, particularly given the technological advances that had taken place since it came into force. Some witnesses told us that the Commission’s proposals were a “good starting point” for negotiations. However, we warned of the damage that would be created by hastily or poorly drafted legislation. These concerns were heightened by the evidence we heard that, while some of the proposals were based on sound principles, there were significant flaws in the Commission’s draft. We identified six such central flaws.

First, we warned that the proposal for a new category of organised trading facility risked creating an overly complex regulatory framework which did not distinguish clearly between organised venues and OTC. We feared that the implications of the proposal had not been fully assessed. We were particularly concerned about the proposal for a ban on “own capital”—that is, the ability of the trader to use his or her own resources to trade on other people’s behalf—and the amount of detail left to delegated acts.

Secondly, while the post-trade transparency provisions held much merit, the pre-trade transparency proposals did not take into account the markedly different characteristics of each sector of the market, particularly in terms of liquidity. The requirement for disclosure could compromise the ability for competition to flourish. We warned against a one-size-fits-all approach to transparency that could have a negative impact on bond markets. We called for a more flexible approach that, while recognising the benefits of transparency, would allow the market to operate effectively.

Thirdly, the Commission also proposed to regulate algorithmic and high-frequency trading. HFT remains a deeply controversial activity and there is a wide spectrum of views about its utility. We recognised the case for circuit breakers, but were concerned that the scope of the proposals was too broad and did not adequately differentiate between algorithmic trading and high-frequency trading. In particular, we warned that the proposal to require algorithmic trading strategies to be in place throughout the trading day was likely to have a detrimental effect on financial markets.

Fourthly, the Commission’s proposals on third country access were deeply flawed. They created a risk that third country firms could find themselves locked out of EU markets, creating the spectre of regulatory retaliation. Such effects could have a particularly damaging effect on the City of London. At the very least, lengthy transitional regimes for existing third country firms were required.

Fifthly, the Commission proposed a number of steps to strengthen investor protection and corporate governance, yet the proposal to restrict the ban on inducements to independent advisers was in our view unworkable, since advisers would simply take steps to avoid being classified as independent. Likewise, the Commission’s proposals on corporate governance were overly prescriptive and did not take account of the diverse size, capacity and business models of the range of market participants.

Finally, we found that, while the European Securities and Markets Authority had a vital role to play in co-ordinating regulation of financial markets across the European Union, there was less consensus about the degree to which it should engage in direct regulation of the financial markets, as suggested in the Commission’s proposals for ESMA to take on product intervention powers. In the light of these flaws, we urged the UK Government, the Commission, the Council and indeed the European Parliament to take all the steps necessary to ensure that the legislation was fit for purpose before it came into force.

What has happened in the nine months since our report was published? The Government’s response, received in October, expressed sympathy with many of the points raised in our report, and we are grateful to the Financial Secretary to the Treasury, the right honourable Greg Clark MP, for keeping us updated on negotiations in the months since. We are aware that negotiations have moved forward, and that significant amendments have been advanced. For instance, progress has been made in Council on improving the provisions on third country access, although we understand that the European Parliament continues to take a contrary view. Perhaps the Minister might tell us a bit more about that. We are grateful to City UK for sending us extra material that will be valuable to us in our thoughts on third country access.

What update can the Minister give us on the progress of negotiations in relation to the six areas of concern that I have identified? What is his understanding of the European Parliament’s position on these issues? To what degree does he believe that the concerns that we raised, and which the Government have said that they share, will be addressed in the redrafted legislation? In relation to HFT, what is his assessment of the findings of the Foresight project, published in October 2012? On a personal note, I am still considerably worried about HFT, although the Foresight group took a much more relaxed view. What is the Minister’s view?

It has also become clear from the Minister’s correspondence that the timetable for agreement had been pushed back, with the scheduled agreement in Council repeatedly postponed. We understand that the Irish presidency decided not to take MiFID to general approach at ECOFIN on 5 March because a number of issues remained open. Which issues remain contentious, and what update can the Minister give us on when agreement on the package will be sought?

MiFID II’s impact on European financial markets, not least the City of London, will be considerable. The Government and their European partners must do all that they can to ensure that the financial markets, and the economies that rely on them, are strengthened rather than undermined by these provisions. However, MiFID II must not be viewed in isolation. There are other pressing issues whose impact on the City, the UK and the EU as a whole are just as great, if not greater.

Last year my sub-committee also conducted an inquiry into the Commission proposals for a financial transaction tax. Contrary to the opinion of many so-called experts, the idea has not died but remains very much alive, in the form of a proposal by 11 European Union member states to introduce a tax under the enhanced co-operation procedure. Only last week, witnesses to my sub-committee told us that the political will in the EU behind this proposal had been underestimated. Indeed, I recall that the CBI spokesman Richard Woolhouse told us that there were now stirrings of recognition in the City that the FTT in its enhanced form could indeed come about.

Do the Government share the complacency we identified? What steps are they taking to ensure that a full and effective analysis of the effects of such a tax on the UK will be conducted? The Minister might like to know that, this afternoon, I talked about this with Mr Lidington, our Minister for Europe, and I tried to sound the alarm bells. As an expert on the City, he will know of some of the new elements introduced in the issuance principle which mean that those trading in, for example, Volkswagen shares in two non-participating countries could be subject to the tax. London could have a much greater responsibility in terms of collecting the tax, perhaps for participating countries.

The euro area crisis has not, of course, gone away. In February, my sub-committee wrote to the Financial Secretary to the Treasury, reporting on the assertions of some experts that the worst of the crisis was over. We were sceptical. We warned that,

“the biggest enemy in the current climate is complacency, whether it be that of European leaders that the euro area has definitively turned a corner, or whether it be that of observers in the UK that the implications of these developments for the United Kingdom can be safely ignored. Positive signs of progress there may have been, but there remains a long way to go before the euro area crisis can be judged to have come to an end”.

I regret to say that recent developments in Italy and, more particularly, in Cyprus have borne out our judgment. The inconclusive Italian election results were a clear demonstration of the political and social pressures to which the euro area crisis is giving rise. More alarming still is the crisis over the Cypriot bailout. The way in which this issue has threatened to spin the entire currency zone back into crisis mode is a clear demonstration of the perils of complacency.

These issues demonstrate the vital importance of the UK Government remaining at the heart of EU discussions, whether it be on the euro area crisis, proposals for a financial transaction tax, or the MiFID II package. The Government may not agree with all the proposals, nor wish to participate in them, but the UK is not immune to the effects that overspill on to us. On MiFID II, as on all these issues, the Government must remain at the negotiating table, ensuring the best possible outcome not only for the City and the UK, but for the EU as a whole. We need to find friends in Europe to be able to do that important and sometimes desperate task. I beg to move.

--- Later in debate ---

[Lord Harrison]

My Lords, I am minded to say that never in the field of markets and financial instruments has there been so interesting, so sexy and so stimulating a debate as has taken place here this evening. I thank all who have participated in it, especially the two Front-Benchers, but also my colleagues such as the noble Viscount, Lord Brookeborough, and the noble Lord, Lord Kerr. I would particularly like to thank our officers, Rose Crabtree and Stuart Stonor, for the work that they do for us behind the scenes, which is very considerable.

I was going to end on a humorous note, saying that I wake up every morning and thank the Lord that the noble Lord, Lord Hamilton, is not like other men. That has been well demonstrated. In fact, he reminds me of the story that William Hazlitt tells in one of his essays about going for a walk with Coleridge. He says that he set off with Coleridge down a Somerset lane. He, Hazlitt, would walk in a straight line; Coleridge was forever diverting, off up on the left, off up on the right, forward and backward and then eventually coming back to join his friend Hazlitt. This debate has been a little bit like that. I began to puzzle why it strayed off the beaten path of MiFID in the way that it has. I think that it was for an important point, and I know that the Minister does not have the opportunity to come back.

I hope that the Minister takes away the intensity of feeling that those of us who were posted away to Committee Room 3 to look at some of these difficult and brain-tingling matters are getting with a greater and greater sense of urgency. This country is not recognising some of the real confrontation that is being borne in upon us by having adopted what I understand to be a negligible position—that of the head in the sand— where we say that these things can be decided by others, but we must progress and let them progress in the way they so wish, and it will not have an effect on us.

I will finish on this one point about Mr Bergmann, who was referred to several times this evening. It was quite clear to us that the defence that the Commission mounts—that this is wholly legitimate under subsidiarity and in other ways because it does not infringe the single market—is simply wrong. It does infringe the single market, and it infringes not the gang of 11 who are going forward, but the gang of 16, who are not participating. If we as the UK are not alert to that and if we are not very careful, we will lose our goose that lays a golden egg. In losing that golden egg of the City of London, we will lose it not just for the United Kingdom: we will also lose it for the European Union. That is why we must take such care. We are in conversation with the FST, Greg Clark, and I was in conversation with David Lidington this afternoon. I hope that the noble Lord, Lord Newby, will take it upon himself, with his deep knowledge of the City of London that he has demonstrated so often, to express the urgency and concern that has caused this debate on the narrow subject of MiFID to spill over into the other dossiers that are before us which cool and chill our hearts.

Motion agreed.