How EU Wholesale Financial Regulation Differs from what the UK would Choose for Itself

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1 How EU Wholesale Financial Regulation Differs from what the UK would Choose for Itself December

2 Europe Economics is registered in England No Registered offices at Chancery House, Chancery Lane, London WC2A 1QU. Whilst every effort has been made to ensure the accuracy of the information/material contained in this report, Europe Economics assumes no responsibility for and gives no guarantees, undertakings or warranties concerning the accuracy, completeness or up to date nature of the information/analysis provided in the report and does not accept any liability whatsoever arising from any errors or omissions. Europe Economics. All rights reserved. Except for the quotation of short passages for the purpose of criticism or review, no part may be used or reproduced without permission. Financial support for this research paper was provided by the Politics and Economics Research Trust (charity number ). Any views expressed in this paper are those of the author and not those of the research trust or of its trustees.

3 Contents Executive Summary Introduction Measures Criteria Criteria Caveats Results Measures the UK would have Introduced or been Affected by Measures that the UK would have Introduced or been Affected by, but that EU Regulation Gold-plates Measures that the UK would not have Introduced, because they Find their Rationale in a Single Market Context Measures that the UK would not have Introduced, because they Address the Needs of the Eurozone or Other Member States Measures that have been Introduced in Other EU Member States, which would still have been Introduced and had an Impact on the UK if Acting Alone Measures that the UK would not have Introduced, because they do not Fit with the UK Conception of Effective Regulation Conclusion... 25

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5 Executive Summary Executive Summary This Europe Economics report for Business for Britain focuses upon EU regulation and tax measures affecting wholesale financial services of vital interest to the City and considers which, of such regulation introduced at EU level, the UK would have introduced itself, acting alone, and which it would not. More specifically, it divides such regulation into: measures the UK would have introduced anyway in much the same form as the EU measure; measures similar to those the UK would have introduced but with substantial gold-plating on top; measures that have meaning only in the context of promoting the Single Market and thus which the UK would not have found it relevant to introduce if acting alone; measures that the UK would not have introduced because they address the needs of the Eurozone; measures that the UK acting alone would not have introduced because it opposes them, but which might have introduced by or within the EU anyway and might have affected the UK even outside the EU; and measures that the UK would not have introduced because it outright opposes them and would not have affected the UK outside the EU. Of the 20 main measures affecting wholesale financial services that were considered, introduced over the past fifteen years: six would have been introduced in their current form (around one third of the total); four would have been introduced in a similar form though the EU version gold-plates what the UK would have done acting alone, thus, together that implies 10 of the twenty, or half, would have been introduced by or affected the UK in some form, even if the UK were acting alone; three would not have been introduced because their central rationale is the promotion of the Single Market, namely the Financial Collateral Directive, the Prospectus Directive and the Payment Services Directive; two would not have been introduced because their central rationale is the promotion of the Eurozone, or the needs of other Member States, namely the creation of the Committee of European Securities Regulators (CESR) and the 10th Company Law Directive; two would not have not been introduced by the UK acting alone indeed would have been opposed but, being introduced within the EU, might have had a substantial effect upon the UK even outside the EU, namely the clearing house location policy and the financial transaction tax; and three would not have been introduced because the UK outright opposes them, namely the Alternative Investment Fund Managers Directive (AIFMD, also known as the hedge fund directive ), ESMA Short Sale Restrictions, and the bonus cap, - 1 -

6 Executive Summary So overall 10 of the 20 measures, or half, would not have been introduced by the UK if acting alone. It is of interest to note that all of the six measures the UK would have introduced or been affected by, even acting alone outside the Single Market, were introduced prior to By contrast, all of the five measures the UK outright opposes have been introduced since the financial and subsequent Eurozone crises. This illustrates the very considerable shift in the balance of UK interest over EU financial services regulation that has occurred in recent years and reviewed in a previous Europe Economics report for Business for Britain. Summary of findings Measures which would have not been introduced by the UK if acting along 10 Measures which the UK has opposed outright: - Alternative Investment Fund Managers Directive (AIFMD) 3 - ESMA Short Sale restrictions - Bonus cap Measures which would have been opposed by the UK acting alone, but could have had a substantial effect upon the UK: 2 - Clearing House location policy - Financial Transaction tax Measures whose central rationale is the promotion of the Eurozone, or the needs of other Member States: 2 - Committee of European Securities Regulators (CESR) - 10 th Company Law Directive - Measures whose central rationale is the promotion of the Single Market - Financial Collateral Directive 3 - Prospectus Directive - Payment Service Directive Measures which would have been introduced but have been substantially gold plated by the EU 4 - Statutory Audit Directive - MiFID - Solvency II - European Market Infrastructure Regulation Measures (all of which predate 2005 and the Eurozone crisis) which would have been 6 introduced in the UK in their current form - Settlement Finality Directive - Accounting rules, e.g. Fair Value Directive - Money Laundering Directive - Market Abuse Directive - Takeover Directive - Transparency Directive - 2 -

7 Introduction 1 Introduction In an earlier report for Business for Britain 1, Europe Economics considered the extent to which the EU-level setting of financial regulation might increasingly not reflect the outlook and interests of the UK and specifically the UK financial services industry. Our view was that the general thrust of EU-level financial regulation before the Eurozone crisis reflected UK traditions of liberalisation, competition and the encouraging of trade. As a result, the regulations set often changed regulation much more in other parts of the EU while, in the UK, they broadly mirrored pre-existing rules. However since the Eurozone crisis there has been an increasing divergence between the thrust of UK regulation, towards increasing the quality of supervision and strengthening market incentives, and the thrust of EU-level regulation, towards extending the scope of regulation, curbing specific behaviours, and necessarily protecting the integrity of the Eurozone. Chancellor of the Exchequer George Osborne stated in early 2014 that if we cannot protect the collective interests of non-eurozone member states then they will have to choose between joining the euro, which the UK will not do, or leaving the EU. Given that the Eurozone is now set to have the collective weight in qualified majority voting to impose any financial regulation it chooses upon the UK, that choice could become increasingly difficult to avoid. We considered a number of potential means of addressing that imbalance and concluded that they were either politically impractical (e.g. a significant increase in the number of permanent non- Eurozone Member States) or only acceptable to other Member States on a temporary basis and with a narrow scope (e.g. the double majority voting rules in place for the European Banking Authority). Since then the approval process for the new Commission, and the UK Commissioner Lord Hill, has confirmed that double majority voting was only accepted as a specific response to a specific issue, rather than the basis for a lasting general settlement. There is therefore continued concern over the extent to which the UK, as a non-eurozone Member State might struggle to maintain a regulatory structure for the financial services industry with which it can be satisfied. In this paper, we extend that analysis by investigating in more detail the extent to which EU-level setting of financial regulation is deviating from the likely path if the UK were setting such regulation domestically. In the earlier research we considered two examples of regulations which encapsulated what we saw the trend in regulation over time. The Takeover Directive (2004/25/EC) made a significant difference to takeover rules in other Member States but changed very little in the UK. It represented earlier EU-level financial regulations which in large part implemented existing UK rules in other Member States. The Alternative Investment Funds Managers Directive (2011/61/EU) by contrast, represented later regulations which reflected the priorities and interests of the Eurozone and despite considerable revisions from the initial draft would not have been introduced by the UK acting alone. 1 EU Financial Regulation A report for Business for Britain, Europe Economics, June

8 Introduction We extend that analysis here by considering the question: to what extent would the major wholesale financial regulations actually implemented at the EU level have been introduced by the UK acting alone? That will not provide a complete answer to the question of how the EU has changed the regulation of financial services in the UK. EU-level setting of financial regulation might change: the quality of regulations introduced, the EU-level setting of financial regulation might introduce compromises which lower that quality or a broader range of scrutiny which improves it; prudential and retail regulation, which is both important in itself and in its indirect effect on the wholesale industry; and the structure of regulations in other Member States, making it less expensive for UK firms to operate across borders (as they only have one regulatory structure with which to comply); increasing economic performance in other Member States and therefore trading opportunities for UK firms; or allowing an effective cartelisation of regulation by other Member States, who are able to use regulatory policy to enact policy detrimental to the UK they would not be able to organise alone. However a consideration of the major wholesale regulations provides an important insight into both the nature of any difference between the EU-level setting of financial regulations and how regulations might have been set by the UK and how that could be changing over time. It therefore provides an important step in an analysis of when and to what extent the EU-level setting of financial regulation might have helped or hindered UK finance. It also might offer some evidence of areas in which any renegotiation might aim to return powers to the UK. The set of regulations which the UK would not have introduced acting alone is probably the set from which it would be most practical to find candidates for reform, exemption or abolition

9 Measures 2 Measures The twenty wholesale financial regulations which we consider in the analysis below include both the direct regulation of wholesale markets and the regulation of banks, the creation of regulators and the regulation of other economic activity where it is particularly salient for wholesale financial market participants. Wholesale financial regulation is defined as the regulation of the provision of financial and insurance services to corporate clients, investors, institutions and public sector bodies, as opposed to the regulation of retail financial services provided to individuals or the prudential requirements which govern the behaviour of institutions such as banks and attempt to promote financial stability such as requirements to hold a certain types of capital. The twenty significant regulations are chosen on that basis from the forty two measures introduced under the Financial Services Action Plan 2 and then other significant regulations introduced since. Direct regulation of wholesale markets: the Settlement Finality Directive (98/26/EC); the Money Laundering Directive (2001/97/EC); accounting rules, such as the Fair Value Directive (2001/65/EC); the Financial Collateral Directive (2002/47/EC); the Market Abuse Directive (2003/6/EC); the Prospectus Directive (2003/71/EC); the Markets in Financial Instruments Directive MiFID (2004/39/EC); the Transparency Directive (2004/109/EC); the Payment Services Directive (2007/64/EC); the Solvency Directives, particularly Solvency II (2009/138/EC); the Alternative Investment Fund Managers Directive - AIFMD (2011/61/EU); the ESMA Short Sale Restrictions (236/2012); European Market Infrastructure Regulation (EMIR) (624/2012); and the ECB clearing house location policy. Regulation of banks wholesale operations: those parts of CRD IV (2013/36/EU) which do not implement Basel III prudential regulations but institute restrictions on variable remuneration (the Bonus Cap). Creation of wholesale market regulators: 2 The Financial Services Action plan, , was the EU s regulatory programme to establish a Single Market in Financial Services. For more details see: (Main Report of European Parliament FSAP evaluation) and pp200ff (UK Country Report) - 5 -

10 Measures the creation of the Committee of European Securities Regulators (CESR), later the European Securities and Markets Association (ESMA). Measures affecting wholesale markets introduced other auspices: the Takeover Directive (2004/25/EC); the 10th Company Law Directive (2005/56/EC); the Statutory Audit Directive (2006/43/EC); and the Financial Transaction Tax (FTT) introduced under Enhanced Cooperation (IP/13/115)

11 Criteria 3 Criteria In assessing whether the UK would have introduced an EU regulation affecting wholesale markets if competence over such regulation did not lie with the EU, we have applied a number of criteria and thought experiments. But before we explain those, it is necessary to set out what we have regarded as the counterfactual i.e. what would have been the situation had the EU not had competence over the setting of wholesale financial regulation? We have assumed: That the EU would exist and that other EU members would coordinate their financial regulation. The UK would not be bound by wholesale financial regulation that it did not set itself i.e. it would not be in the Single Market insofar as that applied to wholesale financial regulation. The UK would be a signatory to most of the key international treaties relating to the financial services industry and a keen participant in international trade, but not have ceded competence over the setting of wholesale financial regulation to the EU. We also assume that, even under that scenario, the UK would still host in London a major international financial centre and therefore, in those areas where UK regulation currently goes beyond the lowest common denominator of EU or international regulation, that continues. 3.1 Criteria When regulations would be introduced There are two main scenarios in which, under our counterfactual, the UK would have introduced (or kept in place) wholesale financial regulation: A) When the regulation in question reflects the UK s own domestic policy preferences. An important case here is where the pre-existing UK regulation (or some UK proposal) closely matches the concept and form of the subsequent EU regulation; B) When the regulation in question would implement an international agreement to which the UK would be a signatory. To understand this, note two cases. First, there are a number of international regulatory bodies of which the UK is a member e.g. the International Organization of Securities Commissions (IOSCO). Such bodies set international standards and sometimes recommend best practice. Second, the UK is a member of major international assemblies such as the G7 or G20 and sometimes at such bodies the participants agree to introduce particular forms of regulatory change. As members of these bodies under the counterfactual, the UK would probably feel obliged to implement international standards, best practice and intergovernmental agreements even in certain cases where these regulations did not reflect the UK s own domestic preferences. It is worth noting, however, that even in certain cases where the UK had or would have introduced a regulation that the EU introduces, the EU version might be significantly more comprehensive or - 7 -

12 Criteria onerous to comply with, thus in a sense (metaphorically) gold-plating the choice the UK would have made for itself (see below, Section 3.1.3) When regulations would not be introduced We identify three classes of cases in which the UK would not have introduced a wholesale financial regulation or tax that the EU has introduced: 1. the regulation that the EU introduces makes sense only for members of a Single Market e.g. rules specifying passporting with the Single Market; 2. the regulation that the EU introduces finds its rationale mainly in issues affecting the Eurozone; or 3. the UK simply disagrees with the measure introduced this might be particularly obvious in cases where the UK formally dissents from the measure at the Council of Ministers or by launching a legal challenge at the European Court of Justice, but there may also be cases where the UK disagrees but does not push it to formal dissent or legal dispute When regulations would be introduced, but EU version gold-plates what UK would have done We note that some regulations fall in a middle ground, reflecting either the existing direction of UK policy (e.g. Solvency II) or international commitments (e.g. MiFID), but with a substantial additional component which reflects distinct EU-level objectives. We have described such regulations with a substantial additional component as measures that the UK would have introduced, but which EUlevel regulation gold-plates. 3 It is obviously rare that EU-level regulations will exactly match the lowest common denominator of international commitments, or the regulations which the UK would have introduced outside the Single Market. It is equally rare than a regulation will include no elements relating to the extensive international agreements or broad statements of principle in fora like the G20. There is thus an ineliminable element of judgement in deciding whether the substance of a regulation would have been introduced at the UK-level; whether that substance reflects a distinctive EU-level regulation; or whether it has been substantially gold-plated in the sense we mean here. The standard we have tried to implement for regulations judged to be gold-plated is those regulations which, while they still reflect the broad priorities and form of international or UK commitments, go substantially further in order to reflect EU priorities such as harmonising regulation and thereby (at least in stated intent) strengthening the Single Market. 3 We note that the term gold-plating is normally used to refer to the explicit process whereby regulatory requirements introduced at EU level are implemented at Member State level (e.g. within the UK) in a manner that adds requirements on top of those mandated by the EU rules. The gold-plating referred to here (a) is implicit; and (b) runs in the opposite direction i.e. the EU-level setting is believed to be additional to what the UK would have chosen for itself

13 Criteria When regulations have been introduced by groups of Member States, not the EU as a whole Not all regulations are passed by or for the EU as a whole. Some are introduced only by subsets of states under enhanced cooperation and some are introduced by agencies such as the ECB where policies apply only to a subset of entities within the EU (e.g. banks accepting last resort lending from the ECB). Some such regulation might be introduced by those Member States or agencies even were the UK outside the EU but might nonetheless have an impact upon the UK and/or UK firms. 3.2 Caveats There is a range of limitations on the data which might answer our central research question here. For example, there is no clear record, over the full period, of patterns of voting on different regulations. At the same time, votes in the European Parliament or at the Council might not provide robust evidence of the extent to which the UK would have introduced a regulation anyway. MEPs or Ministers might vote for a regulation which they would not introduce themselves if they feel that concessions have been made to their position and it would be best to reward those by voting in favour of the resulting settlement. We do not assume here that the fact that UK MEPs or Ministers voted in favour of a measure implies that the UK would have introduced it if acting alone. We do, however, regard a formal vote against a measure by Ministers or (to take a more extreme case) an appeal against the measure by the UK Government at the ECJ as strong evidence that the UK would not have introduced the measure if acting alone. It is also important to note that our purpose is not to determine which regulations are good or bad for the UK or its financial services industry in particular. There may be regulations which would have been introduced anyway which should not have been and regulations which would not have been introduced without the EU, but which benefit the UK. Furthermore, certain regulations that affect the UK within the Single Market may be optimal in that context without being optimal if the UK were not in the Single Market. Our purpose is solely to determine the extent to which the results of EU-level setting of regulation are different from the results which could have been expected if the UK set such regulation domestically regardless of the desirability or otherwise of any differences

14 Results 4 Results There is more information on all of the major regulations included, the criticisms which they have faced, how they have been amended over time and a brief explanation of why we do not believe they would or would not have been introduced without EU-level setting of financial regulations in Table 4.1 below. In the rest of this section, we set out some details on those regulations, particularly those which we do not believe would otherwise have been implemented. 4.1 Measures the UK would have Introduced or been Affected by Of the twenty major wholesale financial regulations identified, we believe that six would, in substance, have been implemented by the UK acting alone, particularly: the Settlement Finality Directive (98/26/EC); accounting rules, such as the Fair Value Directive (2001/65/EC); the Money Laundering Directive (2001/97/EC); the Market Abuse Directive (2003/6/EC); the Takeover Directive (2004/25/EC); and the Transparency Directive (2004/109/EC). 4.2 Measures that the UK would have Introduced or been Affected by, but that EU Regulation Gold-plates There are a further four regulations where regulation would have been introduced, but the EU version is significantly gold-plated relative to any relevant international agreement and/or its likely UK implementation, generally in order to enhance the Single Market: the Statutory Audit Directive (2006/43/EC); MiFID (2004/39/EC); Solvency II (2009/138/EC); and the European Market Infrastructure Regulation (624/2012). 4.3 Measures that the UK would not have Introduced, because they Find their Rationale in a Single Market Context There are some regulations which make sense in a Single Market, but which are otherwise unnecessary for normal trading purposes. It is important to note that these measures may be particularly likely to have led to net benefits to the UK, even though it would not have introduced them acting alone, as they might make it easier for firms located in London to compete for business in other Member States

15 Results The Financial Collateral Directive (2002/47/EC) The Financial Collateral Directive was intended to create a legal framework for the cross-border use of financial collateral. It would therefore strengthen the Single Market in financial services as it would make it easier for firms to transact across borders, as they would more easily be able to accept collateral from those they were transacting with. There is little sense that this addressed a pressing problem, one which the UK would have felt the need to solve, and it is instead intended to represent an extension of the Single Market. It was intended to remove a non-tariff barrier to financial services trade The Prospectus Directive (2003/71/EC) The Prospectus Directive was intended partly to improve the information available to investors and partly to increase the ability for securities to be offered across the EU, by allowing the passporting of documents prepared to meet a single standard. Again there is little sense that this addressed a pressing problem, one which the UK would have felt the need to solve, and it is instead intended to represent an extension of the Single Market. It was intended to remove a non-tariff barrier to financial services trade. At the same time, it was felt to have done so with high compliance costs and new limitations on the ability to choose the home Member State for issues may have been to the detriment of those Member States which had attracted issuers with relatively swift and efficient authorisation services The Payment Services Directive (2007/64/EC) The Payment Services Directive (PSD) contains a range of measures broadly aiming to create a single market in payment services. It does this by closing gaps in the standardisation and interoperability of card, internet and mobile payment systems; attempting to reduce barriers to entry in payment services markets; and changing various other policies. The PSD was criticised for creating high transition costs, with new infrastructure needed, and, although it is plausible that UK financial institutions might have sought to participate in some cross-border payments arrangement, that might have been explored in the first instance as an industry rather than regulatory initiative. Qua regulation the PSD was again intended to extend the Single Market, rather than addressing any particular pressing problem faced by the UK or its financial services industry and its ability to trade. 4.4 Measures that the UK would not have Introduced, because they Address the Needs of the Eurozone or Other Member States We believe that ten would not in substance have been implemented by the UK acting alone, although the sectors or activities concerned are or may have been regulated in other ways. There are first several which address concerns of the Eurozone or other Member States, and are much less relevant to the needs of the UK

16 Results Creation of the Committee of European Securities Regulators (CESR) The Committee of European Securities Regulators (CESR) was established in 2001 to improve coordination between European securities regulators; advise the European Commission on securities regulation; and improve the implementation of community legislation. The body was later replaced by the European Securities and Markets Authority (ESMA). The ESMA is intended to be an EU-level financial markets regulator itself, rather than purely a forum to improve coordination within existing regulators. It regulates credit rating agencies, for example. Our view is that the UK might have joined a Committee of European Securities Regulators which functioned purely as a forum to share best practice and coordinate regulation in certain areas (similar to its membership of standard-setting bodies in other areas, like the Financial Action Task Force for money laundering). However such a body would likely have a broader membership, including non-eu states, and it would not have opted into a shared regulator such as EMSA, generally preferring domestic supervision. Equally, while some regulation of credit ratings agencies might have been chosen, there was not the same concern over sovereign ratings in particular, which were generally thought to be a symptom rather than a cause of sovereign debt crises The 10th Company Law Directive (2005/56/EC) The 10 th Company Law Directive was intended to facilitate cross-border mergers of limited liability companies. It created a framework in which, as a general rule, each merging company is governed by the provisions of its national law applicable to domestic mergers. There is little sense that this was essential to cross-border mergers or that the UK would have felt any need to introduce similar provisions outside the Single Market. Mergers regularly take place across borders outside the EU without such a framework, often through creating a new company. The measure also involved measures related to the participation of employees in the decisionmaking bodies of the acquiring or newly-formed company, which are less relevant to the UK than other Member States where such arrangements are a more important part of normal corporate governance. 4 The European Commission has even floated the idea of creating a state-supported European ratings agency. See, for example The level of competition in the rating industry is a real concern. The Commission believes the [credit ratings agency] market is too concentrated, and more competition and diversity would be positive. The Commission is examining structural solutions including whether a European credit rating agency would be beneficial and whether independent public entities should have a stronger role in the issuing of ratings. There appears to be little to no UK impetus towards the establishment of such an institution

17 Results 4.5 Measures that have been Introduced in Other EU Member States, which would still have been Introduced and had an Impact on the UK if Acting Alone There are two regulations which seem likely to have been introduced for subsets of EU Member States even were the UK outside the EU, which the UK would have opposed, but which might have had a material impact upon the UK The Financial Transaction Tax (FTT) introduced under Enhanced Cooperation (IP/13/115) While the Financial Transaction Tax is not being pursued by the EU as a whole, where there is a national veto on tax measures, and is instead being pursued under enhanced cooperation. 5 Other EU Member States feel that it might provide an additional stream of revenue and increase financial stability. The UK has challenged the tax on the grounds that affects other Member States, particularly the UK with its large financial services sector, and is therefore not a proper subject for enhanced cooperation measures. UK firms which trade with others based in a Member State which does participate will still be taxed. The European Court of Justice initially rejected the appeal, arguing that the timing for a challenge was not right while the legislation is still subject to change. The UK Government more broadly disagrees with the proposed tax arguing that it would increase costs for consumers of financial services products, for example savers, and diminish the competitive position of the European financial services sector. There has been considerable criticism of the potential of transaction taxes to undermine the effective functioning of markets, by making steady adjustments to changing circumstances more expensive. The political dynamics for measures of this kind in the event that the UK was not a part of the EU would be complex. It is not clear, for example, whether the EU would initially have built momentum to introduce a financial transactions tax without the potential inclusion of London, given its status as a financial centre and the competitive implications of the tax The ECB clearing house location policy The European Central Bank (ECB) location policy set out in a Eurosystem Oversight Policy Framework is intended to enhance the stability of the Eurozone area by ensuring that clearing houses responsible for a substantial share of the total market are located in the Eurozone area, 5 Enhanced cooperation is defined by the EU as follows: Enhanced cooperation allows those countries of the Union that wish to continue to work more closely together to do so, while respecting the legal framework of the Union. The Member States concerned can thus move forward at different speeds and/or towards different goals. However, enhanced cooperation does not allow extension of the powers as laid down by the Treaties, nor may it be applied to areas that fall within the exclusive competence of the Union. Moreover it may be undertaken only as a last resort, when it has been established within the Council that the objectives of such cooperation cannot be attained within a reasonable period by the Union as a whole. see

18 Results under the supervision of the ECB. It will then be able to ensure their stability in the event of a systemic crisis. The UK Government argues that this decision will prevent free competition between firms within the Single Market and has therefore challenged it at the European Court of Justice. The UK might potentially seek to object to such a policy even were it outside the EU, but might potentially have fewer fora in which such objections could be heard or have purchase. The location policy for clearing houses set out in a Eurosystem Oversight Policy Framework is intended to enhance the stability of the Eurozone area by ensuring that clearing houses responsible for a substantial share of the total market are located in the Eurozone area, under the supervision of the ECB. It will then be able to ensure their stability in the event of a systemic crisis. The UK Government argues that this decision will prevent free competition between firms within the Single Market and has therefore challenged it at the European Court of Justice. But it seems clear that the UK s key basis for such challenge is from within the Single Market. Outside the Single Market, acting alone, the UK would have no such basis for challenge and the measure might well pass largely uncontested. 4.6 Measures that the UK would not have Introduced, because they do not Fit with the UK Conception of Effective Regulation There are a number of measures which do not fit with a UK conception of effective regulation of wholesale financial services AIFMD (2011/61/EU) The AIFMD is intended to create a European framework for the regulation and supervision of alternative investment fund managers; hedge funds, private equity, venture capital. The management of alternative investment funds was felt to be of potentially systematic importance, creating or transmitting financial shocks. However the regulation increased transaction costs across a broad range of alternative investment sectors, including some of responsible for financing high-growth new firms or corporate recovery, and may therefore have reduced the trend rate of economic growth. It seems likely that, while the UK might have introduced some new regulations on hedge funds following commitments at the G20, the broad scale and high costs of these regulations would not have been emulated by domestic regulation. This reflects a broader difference in the interests of the Eurozone and the UK. While the Eurozone is particularly vulnerable to asymmetric shocks and Eurozone economies often struggle with high unemployment, the UK might be more willing to tolerate funds often responsible for relatively risky investments (it can better absorb the effects when those investments go wrong, with flexible exchange rates and a relatively robust labour market) in exchange for greater growth ESMA Short Sale Restrictions (236/2012) There were concerns that short selling could create considerable systemic financial risk. EMSA regulations therefore required investors to disclose short positions and settle short trades in four

19 Results days, rather than the earlier limit of 30 days. The rules also provided for the suspension of shortselling in some cases. However in the UK there was little pressure for such restrictions, where short-selling was generally seen as a symptom, rather than a cause, of financial distress. The concern was that, by limiting liquidity and reducing the informational efficiency of markets, they might instead exacerbate financial risk. Similar results have been found for short sale bans internationally. 6 This fits with a general pattern where the UK regulatory response to the financial crisis was focused upon enhancing supervision and removing obstacles to market discipline, whereas the response at the EU-level focused on additional control Bonus Cap While the CRD IV legislation is largely concerned with implementing the Basel III prudential regulations, and therefore beyond the scope of this report, there are also provisions to regulate the remuneration of bank employees. The intention is to limit bonuses which it is felt contribute to excessive risk-taking and thereby amplify systemic financial risk. The UK Government has again challenged this measure in the European Court of Justice, arguing that it is beyond the powers of EU-level regulation. The Government s view is that the regulation will impede the competitive position of the European financial services sector and also increase systemic risk as firms may increase base salaries and thus be less able to cut their costs, by reducing the level of bonus payments, in the event of a fall in revenue. 6 Hendershott, T., Namvar, E. & Phillips, B. (2013) The Intended and Collateral Effects of Short-Sale Bans As a Regulatory Tool, Journal of Investment Management, Vol. 11, No. 3, pp

20 Results Table 4.1: Major EU financial regulations Measure name * Directive or other identifier Purpose Based on international regulation? Key criticisms ** Amendments The UK would have introduced similar regulation? Reduce systemic No, but was the Settlement Finality Directive 98/26/EC risk associated with participation in payment and securities settlement systems by making transactions irrevocable beyond response to concerns raised by the Bank for International Settlements on systemic risk, particularly with the introduction of a Amended with Directive 2009/44/EC, which also changed the Financial Collateral Directive, to introduce concept of interoperable systems and increase clarity. Yes. These measures have been described by HM Treasury as providing a key underpinning for the systemic robustness of the financial markets. a certain point. single currency, The rules could be costly to implement and create problems for firms using derivatives as part of a Accounting rules, e.g. Fair Value Directive 2001/65/EC and others Amends accounting directives to reflect international standards. Yes. This implemented international accounting standards. hedging strategy. The criticism more recently has hinged on the potential that the rules are procyclical and exacerbate crises, but that may relate Yes. Most recently with Directive 2013/34/EU, particularly to cut the information requirement for smaller firms. Yes. Reflects international rules to which the UK is committed. more to how those values are used in banking regulation than to the accounting standards themselves

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