EUC Report: MiFID II

Lord Kerr of Kinlochard Excerpts

Tuesday 26th March 2013 Grand Committee

[Lord Kerr of Kinlochard]

Since this is the last report from the committee chaired by the noble Lord, Lord Harrison, to be debated this Session, I should start by paying tribute to him. I have learnt a great deal from serving on his committee. We have benefited from his huge experience, linguistic skills, total impartiality and unfailing good humour. One of the reasons why it has been rather a productive committee is that it has been extremely well chaired, and I thank him. I also thank our clerks, Rose Crabtree and Stuart Stonor, the latter a man of astonishingly fertile mind, deserving of congratulations on his output.

On the matter that we are discussing today, I thank the Government for maintaining a civilised dialogue with us. The government response to our report was a serious point-by-point reply, and at all stages the discussion with the Government has been informative. I hope that what we have said has proved helpful. I contrast the Government’s response with that of the Commission, which always replies to our reports but in this case sent a particularly deadpan response. The Government sent a very interesting and helpful one. Why am I saying this? To make a point, of course. On this matter, the Government have maintained a dialogue with us, but on the matter which has been raised by all previous speakers in this debate because it worries us the most, the financial transactions tax, there is a complete dialogue of the deaf with the Government. We are unable to persuade Mr Greg Clark to engage with us. Our correspondence with him is wholly unsatisfactory, and he has still to address the key point we raised in our report—a much larger and more substantive report than the MiFID report—exactly a year ago.

I would like to take advantage of this debate by putting six questions to the Government about the financial transactions tax. First, do the Government agree that the enhanced co-operation of 11, if implemented, will damage the European Union? Secondly, do they agree that the enhanced co-operation of 11, if implemented, will damage the London market? Thirdly, if so, why did the Government abstain at the January ECOFIN? Why did they not oppose the proposed enhanced co-operation? Fourthly, did they seek before then, and are they seeking now, to construct an alliance against the enhanced co-operation of 11 among our natural allies not participating in it—the Dutch, the Danes, the Swedes, the Poles, the Finns, the Irish and the Luxembourgers? It is not Britain against the rest; we have a majority on our side. Are we making use of that? Is there any active diplomacy?

Fifthly, did we seek and are we seeking legal advice on whether the conditions laid down in the treaty for permitting enhanced co-operation are met, given that these conditions include the need not to prejudice the interests of non-participating member states? Sixthly, why did the Prime Minister at the European Council this month merely take note of this pernicious proposal? According to its conclusions, the European Council noted it. I do not know how well briefed the Prime Minister was. Can the Minister confirm that the Prime Minister is fully briefed on the damage that the FTT proposal could do to the European Union and to the United Kingdom?

Now, to follow the example of the noble Lord, Lord Harrison, I am going to revert to my usual bonhomie and to the subject of this debate. MiFID II is the grandson of the original 1993 investment services directive, on which I was one of the negotiators. Our aim was and still is to create a single market in financial services, which is of course massively in the UK’s interests since the UK is the principal EU provider of such services; they are our largest export; and our share of the EU market has grown as the internal barriers have come down. That is what we hoped, and it is what has happened.

The particular purposes of MiFID II are to create greater competition in trading in securities in order to reduce costs for investors, to apply equivalent regulatory rules to different market models and to enhance and harmonise investor protection—all plainly worthy aims that are beneficial to the EU and the UK. However, the devil lies in the detail. As our report shows, and the Government have agreed with us, we need to be in there fighting. I believe that on this subject, unlike the financial transactions tax, the Government have been in there fighting and that UK negotiators have done very well. It is very important that UK negotiators have been present. Let us suppose for a moment that we were in the nightmare situation of Norway. Let us suppose that we were country members of the single market and we had to take the rules, written in Brussels in the sort of process that we are talking about today, from the fax machine when they had been completed with no say in what they said.

As I say, the Government have done well and the chances are that MiFID II is going to come out okay. However, I have a two-part question for the Government and a comment. My particular concern about MiFID was with the provisions for third-country access, as discussed by the noble Lord, Lord Harrison. The committee thought that they were deeply flawed, and the Government agreed. The proposal was that third-country firms would have to register with the European Securities and Markets Authority and could trade in the EU only if authorised to do so by ESMA, which would be required to certify that these third-country firms came from countries whose home-country jurisdiction imposed requirements equivalent to those in MiFID II and provided equivalent reciprocal recognition of EU firms. Try selling that on Wall Street. It would not fly there, and the effect would be to restrict third-country access into our markets, which would be damaging to them and to us. Clearly, this amounted to a significant risk of shrinking the EU market and hence the London market, since it is the premier location for third-country firms and their branches.

The Commission, which, as I have said, replied to our report, was a little bland on this point. It said:

“The Commission’s objective is to ensure that EU financial markets remain open but are safe for investors … The Commission’s proposal is, therefore, mindful of the need to achieve the correct balance between open access with minimal duplication of administrative and other requirements on the one hand and investor protection on the other hand”.

Yes, Sir Humphrey, I would have been proud of that 20 years ago. The fact is, though, that the balance was not correct. The Government have since told us in their helpful reply to our report that the requirements for equivalence and reciprocal access have been eliminated in Council discussion, one of the reasons why I feel like congratulating them. However, I need to ask a question: is that still the case? Is there a stake through the heart of these third-country provisions? Has the Commission dropped its emphasis on equivalence? If not, and if the Commission is still going on about it, will the right-minded, such as the UK Government, hold firm in Council?

Secondly, as the noble Lord, Lord Harrison, said, what about the Parliament? Compared with my days in Brussels in the early 1990s, the Parliament has—rightly, in my view—much more power than it had then. Sadly, though, our Government have rather less influence than they had, which may be the inevitable consequence of the Conservative Party choosing to distance itself from the EPP in Brussels and Strasbourg, thus sharply reducing its chances of obtaining senior and influential positions in the Parliament, and of course removing a principal opportunity for influencing and alliance-building with like-minded Members of the Parliament. How confident are the Government that a good deal in Council—if it is a good deal, which I think it probably is—will not unravel in co-decision procedures with the Parliament? Are the Government acting on the first point that we made in our report when we said,

“we particularly urge the Government to ensure that they liaise with and pay due attention to the European Parliament in its consideration of the MiFID II proposals”?

Are we, in alliance with our friends in Council, lobbying hard in Strasbourg? Are Ministers going to Strasbourg specifically to talk about MiFID? Are all British MEPs, of whatever party, fully briefed on the importance of this directive for the City of London and the risks to us in the United Kingdom if it all goes wrong?

That is nearly all I want to say, but since the debate has ranged a little beyond MiFID, I will make one final point. As eurozone Ministers, along with those aspiring to join the eurozone, get together more and more closely—in the past fortnight they have been meeting a great deal—to discuss banking union, FTT, bail-outs and bail-ins for Cyprus, it becomes more important, as the noble Lord, Lord Harrison, pointed out, that we in the UK try even harder to stay alongside the debate or, ideally, at the heart of it, among the same people on the EU financial services legislation that is so important to this country. There will be caucusing among eurozone and eurozone-plus members. There is nothing we can do about it because it will happen informally. The Commission will try to prevent it. If in the end we wanted to go to the Court, we would obtain valueless rulings on our side. Caucusing is wrong but it will happen. And “les absents ont toujours tort”.

The best way of limiting the risk and mitigating the damage is to be as active as we can in making the European case for open markets. We should bring other countries’ Ministers, officials, European Parliament Members, journalists and opinion-formers to look at the City and understand the benefit that it represents for the EU as a whole—that of having a great global market on EU territory. This grows more important with every passing month and I hope that the Government, who I know do not agree with me on a number of things, agree with me on this and will try very hard.

I will say one last thing. Given the identity of the two speakers who are to follow me, I will quote from one of my heroes, Lord Thomson of Monifieth. George Thomson was one of our two initial commissioners. In 1999, talking about 1973 and the experience of going to Brussels with Christopher Soames, he wrote:

“I recall the remark of a wise Dutch Commissioner … ‘My dear George,’ he said, ‘there are now two countries in the Community who are stubborn about defending their national interests, France and Britain. But a word of advice … France always describes opposition to her position as a betrayal of Europe. Britain makes it appear as if Europe is betraying Britain. Not the best way to get results!’”.

It was not the best way then, and it is not the best way now.

--- Later in debate ---

[Lord Newby]

My Lords, like other speakers, I congratulate the noble Lord, Lord Harrison, and his committee on producing such a comprehensive and thoughtful report on such a technical subject. I hope that noble Lords will forgive me if I start by dealing with some of the technical issues that the report covers before I get on to some of the broader issues that we have discussed.

As noble Lords have accepted, since it came into force in 2007, MiFID has had a major impact on how EU financial markets operate. This in turn has fed through to a significant impact on the wider economy. The directive has been instrumental in reducing barriers to trade in financial services and increasing competition in trading services. To build on these benefits, the Government agree with the committee that a review of MiFID I was necessary. The Commission’s proposals for a new directive and regulation broadly seek to address three areas where problems have arisen: negative side-effects resulting from the implementation of the original legislation; technological developments in how financial markets function; and issues exposed by the financial crisis.

There is much to welcome in the proposals. For instance, the creation of a new category of trading venue, called the organised trading facility, will capture virtually all organised multilateral trading. Another objective of the review—greater transparency in financial services—should help to protect investors and generally lead to greater efficiency in price formation. A policy of open access between trading venues and clearing houses will remove an important obstacle to competition, helping to create a more competitive single market in clearing and trading services. However, the policies contained in the MiFID review must be extremely carefully designed. The Government’s primary focus is ensuring that the measures contained in the review meet their objectives and do not damage competition or the efficiency of financial markets.

First, the Government share the committee’s concerns over the design of the organised trading facility. The Government continue to work hard in negotiations to try to ensure there is sufficient detail in primary legislation so that the proposals achieve their purpose.

Regarding the Commission’s proposal to extend the rules on market transparency to non-equity markets, the committee rightly notes that we must avoid a one-size-fits-all approach, as trading characteristics can differ significantly across asset classes. As the committee also observes, without proper understanding of these issues there could be an impact on liquidity and the cost of capital. The Government agree with both these points and continue to prioritise these issues in negotiations.

The proposals also increase transparency for so-called systematic internalisers. The Government believe that the systematic internaliser model has a role to play, but we acknowledge the committee’s comments that this category has not been heavily utilised and that some clarification of the purpose of the regime may be helpful.

As a consequence of recent technological advances in financial markets, the Commission has proposed new rules governing the operation of high-frequency trading. As the committee recommends, the Government’s position is that measures applied to algorithmic and high-frequency trading should be firmly grounded in evidence about its real impact. The Government note the welcome contribution that the Foresight report has made in this regard.

The Commission’s proposals also introduce an EU-wide third-country regime. This would harmonise the rules under which investment services can be provided by non-EU firms into the EU. Although we believe that there would be an economic rationale in extending the benefits of the single market to third-country firms, we fully agree with the committee’s comments on the global nature of financial markets. Our prime objective is to ensure that the UK, and indeed the entire EU, remains open to trade in financial services worldwide. The UK has worked hard in Council to amend the proposal and we believe that the current compromise will avoid the disadvantages and difficulties that the committee has identified.

While we support greater transparency in commodity markets, the Government agree with the committee that price volatility in these markets is dependent on a range of factors. In particular, in 2011, the G20 commodity study group was clear that fundamentals—in other words, supply and demand—have been driving commodity prices. The Commission’s proposed rules for commodity markets did not recognise this, placing undue emphasis on a particularly rigid regulatory regime. However, we are satisfied that the current compromise in Council provides for a suite of position management tools that will ensure that commodity derivatives markets are properly regulated throughout the EU.

Turning to the powers granted to ESMA under the MiFID review, the Government agree with the committee that ESMA has a strong coordinating role to play. However, it is important to ensure that powers assigned to EU agencies are in accordance with the treaties and relevant EU case law. The outcome of a legal challenge on certain powers conferred on ESMA in the regulation of short selling and certain aspects of credit default swaps will inform our long-term approach on this issue.

Finally, the Government believe that the Commission’s proposed measures to improve investor protection could be strengthened. However, there is considerable pressure from other member states to not implement an inducements ban at EU level. Therefore, the Government’s main objective in the remaining discussions is to ensure that the UK is still able to implement tougher measures domestically under the FSA’s retail distribution review.

The noble Viscount, Lord Brookeborough, talked about inducements. Our view is that the evidence suggests that inducements are being shown time and again to bias advice. Mis-selling, as we have seen many times in the UK, is an extremely serious issue and we must protect people against future scandals. It is relevant that research for the European Commission by Synovate suggests that as many as 57% of investment recommendations in Europe are unsuitable. We cannot ignore this very serious and ongoing issue.

I will say something about where we have got to in the negotiations. Our current expectation is that the Irish presidency will try to seek political agreement in May, although no firm schedule has yet been confirmed. There are still a few areas of outstanding disagreement. The main obstacles are the open access provisions, which Germany and a group of member states oppose, and the equity transparency regime, where France and some others want to see a uniform standard of transparency across all venues. On both these issues, the Government’s objective is to ensure that the regulatory framework does not impose unnecessary costs on the end users of financial services and supports growth in the real economy. We continue to work constructively on these high priority areas in Council, with the aim of reaching a compromise.

Questions were asked about the European Parliament and whether we are trying hard in both the Council and the Parliament. The Parliament compromise was agreed in September. As it stands, it is likely that the biggest difference between the Parliament and the Council will be the third-country regime. Although the Council has deleted much of the regime, Parliament has broadly opted to retain it, but with some positive amendments. However, in many other areas the Parliament and the Council texts are broadly aligned. We have been lobbying hard in Strasbourg and are working extremely hard in the Council to ensure that we get the best possible outcomes.

I turn to some of the broader comments which have been made. It is fair to say that they have occupied the bulk of this afternoon’s deliberations. There has been a lot of discussion about the financial transaction tax and where we are on it. The noble Lord, Lord Kerr, asked me six questions about that tax. As he knows, the proposals are relatively recent; some aspects of them are relatively unclear and the Treasury is, at the moment, analysing the proposals and seeking to understand them in greater detail.

[Lord Kerr of Kinlochard]

I have tremendous respect for the noble Lord, but that is the kind of answer we have been getting for a year on the financial transactions tax. The Council made a decision in January, with the UK—absurdly, in my view—abstaining. The point of principle is whether we agree that they may go ahead with levying a tax among 11 countries but requiring the rest of us, including the UK, to collect the tax for them and send it to them. Do we agree to damage our market? Do we agree that they have the right to do that? The key question is whether our interests are adversely affected. If so, they do not have the right to do it. Why did we abstain?

[Lord Newby]

We agree that they have the right to do it. The question which the noble Lord asked about whether this measure would damage the EU and the UK is not one to which there is a simple or straightforward answer. There are two completely different views about the impact of this tax on London. To a certain extent, we will not know, until it is implemented, which of these two views is correct. One view is that London will benefit significantly because we are out of it. If you look, for example, at what happened in Sweden, which had a transaction tax, the bond market collapsed totally and Sweden had to abolish it. If you take that view, a financial transaction tax is good for London.

Other people take a completely opposite view. The modalities of collecting the tax, and exactly how those will work, are clearly, from everything that the Commission has said, a work in progress. It is not, I believe, a unique suggestion within EU law and practice that member states will collect taxes that revert to other member states. I do not think it is a matter of principle; it will be a matter of practice and whether it is possible to put in place a practical solution.

[Lord Kerr of Kinlochard]

Surely, the complacent school of thought that says all the business will flow to the United Kingdom, others will damage themselves and we stand to gain, does not still exist in Whitehall. Surely, Whitehall has now persuaded itself that putting more grit in the cogs of the London financial markets is a bad thing, as is trying to persuade two American banks doing a transaction in London that, according to an instrument which originated in Germany, we should collect from both banks not for the British Exchequer but to send the money to the Germans. Surely, Whitehall has decided that that scenario is mad because the American banks will not trade in London if we apply this absurd regime. Surely, Whitehall is clear that we are approaching a crossroads and that we do not know which road to take. What are we going to do? Are we going to sit at the crossroads?

We have to decide what to do on the balance of the evidence. Surely, the balance of the evidence is overwhelming that this measure is a bad thing for the EU and a bad thing for the UK. Eleven countries do not agree, but I guess that 15 or 16 other countries do agree with us. Are we trying to construct an alliance with them or have we, as the noble Lord, Liddle, said, such a pariah status that we cannot construct an alliance? I do not believe that. I still think that this situation could be remedied. Are we going to go to law? We need legal advice on who is right. I believe that if we could be damaged by this measure, and the chances are that we will be, it is not permitted under the treaty. Therefore, I do not understand why we abstained and I do not understand why the Prime Minister was silent.

[Lord Newby]

My Lords, if I did not know the noble Lord better, that speech would seem to me to typify the attitude that gets us into difficulty. He asserts with absolute certainty that the French do not know what is best for them, the Germans do not know what is best for them and the other nine who have signed up to this tax do not know what is best for them as he believes that it will be very damaging.

[Lord Kerr of Kinlochard]

I am sure that none of my friends or none of the noble Lord’s friends would do this but it is just possible that some people in France would like to damage the London market.

[Lord Newby]

I am sure that some people in any country will want to do virtually anything, but the question I was addressing was whether the 11 countries that have signed up to this tax can be dismissed as not knowing what is best for them, even though we are deeply sceptical about it and are not going to sign up to it. We have had a number of debates in your Lordships’ House about Greece, for example, in which some noble Lords seem to have known what is best for Greece. It is just that the Greeks have not agreed. We have to let other member states move forward with this within the rules because they are keen to do so.

[Lord Newby]

I think that my noble friend should ask them because I have not the faintest clue what was in their mind, but they have now formed a view. If the German Government have a settled view, even if I do not agree with it, I would not write it off as a mad one. I am sure that we will come back to the financial transaction tax, but it is not unreasonable to say that an extremely complicated tax using very difficult mechanisms to make it work should necessarily be capable of instant analysis in terms of how we are going to deal with it. We are looking at it. We have had the proposal for only a few weeks, and my right honourable friend Greg Clark, as the noble Lord, Lord Harrison, pointed out, is actually one of the better Ministers in any Government in terms of working with Parliament and, indeed, across the EU. I am sure that in due course he will come back with a full description of our response.

[Lord Kerr of Kinlochard]

I am testing the Minister’s patience, but we are now past the point where we can affect it. The only question remaining for us is whether we can overturn it. After the January ECOFIN it is now up to those who participated in it to devise the tax as they think is best for them. We cannot affect that, but we will be obliged to collect it. I am not clear what we are working hard on at the moment. What are we trying to do? We are not in the room any more. I would say that we ought to try to derail this exercise by going to law. We need to mount a legal challenge. We must create a political alliance and mount a legal challenge.