EUC Report: MiFID II

Lord Newby Excerpts

Tuesday 26th March 2013 Grand Committee

[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 Hamilton of Epsom]

Does my noble friend accept that at one stage the Germans were very much against this proposal and then they changed their mind? Was it that they did not know what was best for them originally and then they did know subsequently, or did they get it the other way round?

[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.

--- Later in debate ---

[Lord Newby]

My Lords, I am conscious of the time. Much as I would like to go on until eight o’clock on this subject, I think that we are going to have to return to it.

I shall turn to some of the other points that have been made in the debate. I would say to the noble Viscount, Lord Brookeborough, that one person’s harmonisation is another person’s single market rules. Sometimes harmonisation works very much to the benefit of the UK and sometimes it does not. We have to take this on a case-by-case basis, but let us remember that by common consent the single market has been very beneficial to the UK. If we can, we want to strengthen it even if, as inevitably will be the case, some of that strengthening includes common rules.

[Viscount Brookeborough]

I did not say that harmonisation was not a good thing, rather I looked at the way this tax is being brought forward. They were talking about harmonisation before they started raising the money. They did not like to talk about why they were raising the money and doing it only over a certain number of countries.

[Lord Newby]

I am grateful to the noble Viscount for that clarification. The noble Lord, Lord Kerr, asked about the benefit of the EU to the City as a whole, and both whether the Government recognise that and whether are doing anything to promote it. There is no doubt in my mind, having watched the Government in action, that they absolutely understand the role of the City and how having a strong financial services sector is immensely valuable to the UK and to the EU. The Government themselves are working very hard, as noble Lords have said, on this directive and others to make sure that we end up with proposals which are compatible with the ongoing success of the City.

One of the frustrations I felt before I was a Minister and which, to a lesser extent, I still feel, is that the City is not always its own best advocate. Although things have improved considerably with the formation of TheCityUK, and there is now a much wider recognition that the financial services sector needs to get its act together, as it were, to promote itself, there is still some way to go. Although the UK Government are active in the Council and in the European Parliament, they need the UK financial services sector to be independently active in those institutions as well. There was a period when a lot of senior people in the City felt so battered with the experience that they had following 2008 that they were not willing to put their heads above the parapet and make the arguments. I think that that phase is over, to a certain extent at least, and the Government are encouraging them very much to do that. I am very grateful to the noble Lord, Lord Kerr, for quoting Lord Thomson of Monifieth. He, of course, was from that great tradition of canny Scots who could fully understand the benefits of engaging with the EU.

I will make just two points before I finish in response to the noble Lord, Lord Liddle. First, he talked about asymmetries. There are a number of asymmetries. Looking at the future of this directive, we are talking about the possibility of making considerable progress while Ireland still has the presidency. However, the amount of financial services expertise which Lithuania is going to bring to the party in the second half of the year is relatively limited. It is a terrible burden on the officials and Ministers from small member states who have to grapple with what, by common consent and as anybody who has read the report knows, is an immensely technical subject. Virtually the only people other than members of your Lordships’ committee who understand it are the people who work in it every day. The truth is that there are not many of them in small member states, which is an asymmetry. Clearly, there is also an asymmetry between the Commission and the UK. There is one asymmetry that we can benefit from by using our expertise. I was extremely interested that, despite the fact that we are not in the euro, a group of Treasury officials went to Cyprus at the weekend in order to help sort out that problem. It will be very interesting when they get back to see what they have learnt from it.

The final point is about how we exercise influence in an environment where we are not part of the euro-in group. In my view, the model—which I have seen in operation—is that adopted by my colleague in another place, Ed Davey, when he was in BIS, who established something called the “like-minded growth group” for promoting the single market. At every point, Mr Davey carried in his pocket a little laminated piece of paper which showed the voting strength of every member of the 27, and he was forever working out how you got that qualified majority or majority. He worked very hard, and succeeded, at getting a majority of member states, both euro-ins and euro-outs, to co-operate to promote the single market. That is a model that I think is still pursued within BIS. We have got to, as the noble Lord, Lord Kerr, said, be very active working out where we can form alliances, which we can do on many things. One of the ironies about the current financial circumstances is that we, as a euro-out, have much more in common with some of the northern European countries that are trying to impose fiscal discipline. For good or ill, we are now something of an expert on that in this country and we need to make the most of it. There are no permanent alliances; you have to rebuild and refresh them. One of the challenges for the Government—or any Government—is to do that as best they may.

Finally, reverting to the splendid report that we have been discussing this afternoon, the Government welcome it and agree with all the points it raises. We accept, as I have attempted to explain, that the devil is in the detail. The Government will continue to negotiate carefully so that MiFID II does, indeed, get it right for the City and, most importantly, for the users of financial services.