Shaping legislation: UK engagement in EU financial services policy making

Shaping legislation: UK engagement in EU financial services policy-making RESEARCH REPORT PUBLISHED BY THE CITY OF LONDON CORPORATION

Shaping legislation: UK engagement in EU financial services policy-making is published by the City of London Corporation. The author of this report is Norton Rose Fulbright.

This report is intended as a basis for discussion only. Whilst every effort has been made to ensure the accuracy and completeness of the material in this report, the author, Norton Rose Fulbright, and the City of London Corporation give no warranty in that regard and accept no liability for any loss or damage incurred through the use of, or reliance upon, this report or the information contained herein. Norton Rose Fulbright LLP maintains a position of neutrality on the UK Referendum on whether or not to remain in the EU. June 2016 Š City of London Corporation PO Box 270, Guildhall London EC2P 2EJ www.cityoflondon.gov.uk/economicresearch

Shaping legislation: UK engagement in EU financial services policy-making RESEARCH REPORT PUBLISHED BY THE CITY OF LONDON CORPORATION

Shaping legislation: UK engagement in EU financial services policy-making

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Contents

Executive Summary

4

Introduction

6

1 Overview of EU legislative process

8

2 Case Studies

14

Solvency II

15

Alternative Investment Fund Managers Directive AIFMD

22

European Market Infrastructure Regulation EMIR

28

Capital Requirements Directive and Regulation CRD IV

34

Markets in Financial Infrastructure Directive and Regulation MiFID2/R

41

3 Conclusions

48

Annex

55

Annex I: Glossary

55

Annex II: Bibliography

57

Annex III: Interviewees

60

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Shaping legislation: UK engagement in EU financial services policy-making

Executive Summary

This report examines the UK Government’s influence in shaping EU financial services legislation. It assesses the extent to which the UK has engaged with and influenced legislation successfully, and the ability of countries outside of the EU to negotiate policy.

The report recommends ways in which the UK could improve its influencing potential in the future.

The research analyses five legislative initiatives proposed and adopted in the last ten years:

the UK’s and raise the standard of European insurance capital requirements.

The Solvency II Directive; The Alternative Investment Fund Managers Directive (AIFMD); The European Market Infrastructure Regulation (EMIR); The Capital Requirements Directive and Regulation (CRD IV/CRR); and The Markets in Financial Infrastructure Directive and Regulation (MiFID II/MiFIR).

Alternative Investment Fund Managers Directive (AIFMD) – the UK maintained London’s status as a global investment hub by preserving the National Private Placement Regime.

These are all significant initiatives, which either have, or soon will, affect a wide range of UK-based financial services firms. The analysis draws on a range of resources including interviews with current and former EU institution and member state government officials, legislators, lobbyists and other stakeholders.

The report shows that the UK Government has played a significant role at the EU level in formulating legislation relating to the financial services sector. Key successful outcomes have included: Solvency II Directive – the UK shaped EU legislation to match

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The European Market Infrastructure Regulation (EMIR) – UK Government efforts ensured that clearing houses such as ICE Clear and LCH. Clearnet could continue to operate without restrictive rules that would discriminate against them for being outside of the Eurozone.

The Capital Requirements Directive and Regulation (CRD IV/CRR) – allowed the UK to set high capital reserve standards for financial institutions in Europe while maintaining national discretion to set higher rates.

Markets in Financial Infrastructure Directive and Regulation (MiFID II/MiFIR) – the UK preserved the passporting regime set out in MiFID, which was key for UK-based financial

firms’ ability to access 500 million European customers.

The report also examines the role of governments whose countries have access to the EU’s Single Market but are not members, namely Norway, Iceland, and Liechtenstein, and in a different framework, Switzerland.

Outside of the EU, states are treated as a ‘third country’ under the European financial services legislation. Countries can either adopt EU legislation or have to go through a rigorous and lengthy equivalence assessment procedure and corresponding registration or authorisation requirements in order to access the EU market.

Looking at the non-EU member states with preferential access arrangements, the case studies suggest that these countries have had little or no opportunity or ability to shape financial services legislation, even where they have had to adopt or emulate this legislation. Indeed, the case studies highlight that although EEA signatories may receive preferential market access, this comes at a cost of accepting that national firms will be supervised on the basis of rules and decisions the countries have no say in drafting.

If the UK were not a member state, this would mean that UK-based banks, investment firms, insurance companies, asset managers or market infrastructure providers would not be able to benefit from the ‘passporting’ regime, i.e. they would not be able to use the UK as a base for offering their services

across the EU. London’s role as a global financial centre means that many of the financial institutions basing here come from outside of the EU; the ‘passport’ is key in enabling them to access the EU market from the UK. The analysis shows that the UK Government’s effectiveness and influence in financial services legislation – and its ability to deliver positive outcomes – is a function of its membership of the European Union. For those countries outside of the Union with preferential access to the Single Market, government policy-making for the financial services sector is tightly constrained and these countries have little, if any, influence on EU legislation under any EEA Agreement, European Free Trade Association (EFTA) or variant arrangements.

While the UK has had to accept compromises through the negotiation process, such as group support provisions in Solvency II, the five case studies demonstrate that the UK has gained far more often than not through its involvement in the legislative process.

Nevertheless, there are areas in which the UK’s role in shaping EU financial legislation can be strengthened. This report provides recommendations for how the UK can better shape future legislation as an EU member state.

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Shaping legislation: UK engagement in EU financial services policy-making

Introduction

The European Single Market seeks to remove legal and regulatory obstacles that affect the free movement of goods and services between the 28 member states of the EU, comprising 500 million consumers. The harmonisation of rules and regulations across EU member states facilitates intra-EU trade and the exchange of services. As services across multiple sectors account for over 70% of economic activity in the EU, the associated regulations impact the day-to-day business of a large number of companies based in EU member states.

Rules and regulations originating from the

and the European Parliament. As a large

EU have an increasingly large impact on

member state hosting a global financial

the UK economy, including its financial

services centre, the UK is well placed to

services sector and London’s lead position

play a key role in that legislative process.

as a global centre. The financial services industry is vital to the UK economy and

With the UK electorate being asked to

to the City of London, and the EU is a

consider whether to leave the EU, it is

key market for these services – both for

important to assess the role the UK plays

domestic firms and non-EU firms based in

in the EU decision-making process. A

the UK, who can ‘passport’ their services.

number of arguments for leaving the UK are based on the premise that the UK must

The financial services sector has been

abide by legislation dictated by Brussels,

subject to an unusually high level of new

without acknowledging the role that the

regulation since 2009. A wave of post-crisis

UK plays in forming this. Likewise, there

reform has affected all parts of the financial

are presuppositions that EU legislation is

market, from the insurance sector, through to

unfavourable to the UK, either because the

alternative investment funds, asset managers,

UK opposed the legislation or was outvoted

banks and derivatives markets. While some

on the final content. This paper seeks to test

of the reforms were triggered by the financial

these assertions and build the full picture

crisis, others have their roots in the continuous

of the UK’s experiences and outcomes. It

development of the Single Market.

explains the mechanisms of the EU decisionmaking process and analyses five pieces

The European Commission drives this

of recent significant financial services

legislative change by proposing draft

legislation as case studies to evaluate the

legislation and overseeing its subsequent

UK’s role in the EU legislative process.

implementation. Actual decision-making

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power is shared between the Council of

The methodology for this study combines

the European Union (the member states)

research and analysis of legislative

documents and publically accessible

Each case study covers the following

government documentation, with twenty

aspects:

interviews. These interviews provide insight from policy makers, legislators, lobbyists

p a review of the background of the

and others involved in the drafting of this

legislation in question, includingthe

legislation, either through formal roles in the

context and motives behind the

legislative review process, or in representing industry or consumer groups seeking to

publication of the Commission’s proposal; p analysis of the key issues that emerged

shape the legislation.

during the legislative process, reviewed in

The report covers the Solvency II Directive,

and that of other EU member states,

the light of the UK Government’s position the Alternative Investment Fund Managers

the European Parliament and other

Directive (AIFMD), the European Market

stakeholders;

Infrastructure Regulation (EMIR), the Capital

p an assessment of the UK’s legislative

Requirements Directive and Regulation

negotiations and key lessons learnt during

(CRD IV/CRR) and the Markets in Financial

the process;

Infrastructure Directive and Regulation

p an analysis of third country elements of

(MiFID II/MiFIR). The diverse roles of the

the legislation, which govern the access

interviewees enabled the cross checking of

to EU markets from non-EU countries.

recollections between respondents as well as the comparison of experiences during different legislative negotiations.

The paper concludes that the UK has played a significant role in shaping EU financial services legislation, largely

These case studies cover key segments of

succeeding in securing more favourable

the financial services industry and include

outcomes. The UK Government has

crucial capital and conduct rules for

generally supported EU financial services

banks, investment firms, fund managers

legislation and played an active role

and insurers. Each piece of legislation

in forming it. As demonstrated by the

was, or remains, the focus of significant

level of influence of third countries, if the

member state lobbying throughout all

UK had been outside of the EU during

stages of the legislative process. The

these processes, there would have been

analysis demonstrates that often securing

significant barriers to influencing the

a favourable outcome expends a lot of

outcome of negotiations that would still

political capital and requires long-term

have impacted UK-based financial services

coalition building. Influencing legislation

firms directly and significantly.

does not start when a proposal is presented by the Commission, nor does it finish when the final legislative text is published in the EU Official Journal. The process of influencing legislation spans from engaging with the Commission’s preparatory work all the way through to engaging with implementation rules.

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Shaping legislation: UK engagement in EU financial services policy-making

1.

Overview of EU legislative process

8

In 1951 the European Coal and Steel

Parliament) and the Council of the

Community (ECSC) was set up to unite

European Union (the Council) can adopt

European countries economically and

measures necessary for the approximation

politically with the aim of securing lasting

of a member state’s national laws to ensure

peace following World War II. This led to

the functioning of the Single Market. In the

the European Economic Community, an

context of financial services, this has led to

economic area without internal frontiers

harmonized rules on banking, insurance,

expected to create greater economic

securities and investment funds, financial

prosperity and stability. The idea that

market infrastructure, retail financial services

people, goods, capital and services should

and payment systems. The majority of

move freely across borders was the driving force behind subsequent treaties and the eventual creation of the European Union

financial legislation is adopted through the ‘ordinary legislative procedure’ by which the European Commission puts forward a

(EU). Over time the EU has developed into

legislative proposal and the Parliament

more than an economic community, and

and the Council (which brings together EU

legislates on a wide range of issues.

member states) act as co-legislators with equal say over the final legislative text. This

The EU’s power to legislate on financial

process provides the opportunity for the

services lies in Article 114 of the Treaty on

UK to influence the outcome of legislative

the Functioning of the EU (TFEU), which

negotiations.

stipulates the European Parliament (the

FIGURE 1

Opportunities for member state influence

Regulators and industry participate in Commission hearing, consultation

Scrutiny of draft legislation by national parliaments

1

Proposal drafting phase

2

Dialogue between UK Government and European Commission officials

Council negotiations take place between representatives of 28 national governments

Legislative negotiations UK MEPs vote on the European Parliament position based on guidance from their party

UK representatives at supervisory authorities involved in drafting technical legislation

All final legislation is signed off by the ministers from 28 national governments

3

Implementation

Commission expert committees made up of national representatives assist in drafting implementation measures

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Shaping legislation: UK engagement in EU financial services policy-making

The reasons the European Commission

internal ‘impact assessment’ of the proposal.

will propose legislation vary. It may need

These formal and informal steps allow the

to legislate because various laws in the

Commission to draw on the experiences of

member states clash and need to be

a broad range of experts including national

harmonized for the EU Single Market to

ministries, industry representatives, non-

function. There might be a new international

governmental organisations and member

agreement that needs to be ‘translated’ into

state bodies, such as national regulators.

EU law in a uniform way. Legislation may be outdated and in need of revision.

The Commission has a role in the

A Commission proposal often comes

law and is sometimes called the ‘guardian

after informal conversations between

of the Treaties’. Importantly however, the

relevant Commissioners and member state

Commission only has the power to propose,

representatives, public consultations and an

not to adopt legislation.

implementation and enforcement of EU

FIGURE 2

Pre-legislative phase Commission legislative initiative Based on EP resolution: Council request; Commission work programme; review of existing legislation; international initiatives

Public Consultation

Public Hearing

Draft Proposal

Impact Assessment

Consultation of other Commission departments

Approval by College of Commissioners

Commission proposal

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The ‘ordinary legislative procedure’ is also

groups are composed of representatives of

known as ‘codecision’. It gives equal weight

each member state. Within the Council, almost

to the European Parliament and the Council.

any proposal on financial services needs to be

Both these institutions will make their own

backed by at least 55% of EU member states,

amendments to the Commission’s proposal,

and 65% of the EU’s population. However, the

followed by negotiations to find a common

Council rarely votes formally and member states

position.

prefer to broker informal agreements in order to reach consensus.

The European Parliament considers proposed legislation in one of its 20 standing committees.

Parliament and Council reaching their

The responsible committee appoints a

respective positions on the Commission’s

rapporteur who leads its work as well as shadow

proposal is often the starting point for the

rapporteurs from other political groups that

informal, relatively new process of ‘trilogue’

seek to steer the report in their political direction.

negotiations. In these negotiations the European

Other Members of the European Parliament

Parliament is represented by the relevant

(MEPs) on the Committee can propose

rapporteur and ‘shadows’ and the Council

amendments too. Internal negotiation between

by the member state holding the Council

the rapporteur and shadows is followed by

Presidency. The Commission has an advising and

a vote in committee and the adoption of a

facilitating role and ensures that what is decided

committee report.

does not clash with the Treaties. Importantly, only the Parliament and Council, home to MEPs and

The Council works in parallel with the Parliament

UK Government representatives respectively,

on amending the Commission’s proposed

can decide on the shape of the final EU

legislation via numerous working groups that

Directives or Regulations.

scrutinize legislation at a technical level. These

FIGURE 3

Legislative negotiations Commission proposal

European Parliament scrutiny (MEPs)

Council scrutiny (EU Member States)

Committee negotiations and report

Working Group negotiations

Adoption of EP position

Adoption of Council position

Informal ‘trilogue’ negotiations result in one text.

The EP and Council decide, advised by the Commission

Final EP adoption of agreed legislation

Final Council adoption of agreed legislation

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Shaping legislation: UK engagement in EU financial services policy-making

On financial services, legislative negotiations

national competent authorities sit. A national

are often complemented by ‘implementing’

competent authority can in principle disapply

or ‘Level 2’ measures – a layer of technical

such guidelines, using a ‘comply or explain’

legislation to fine-tune implementation in

procedure.

the member states. These are adopted by the Commission with substantial input from

The case studies that follow demonstrate that

the European Supervisory Authorities (ESAs) –

the UK has an opportunity to exert influence

the European Banking Authority in London

at all key stages of the legislative process. It

(EBA), the European Securities and Markets

can influence the Commission via its national

Authority in Paris (ESMA) and the European

Commissioner or seconded national experts,

Insurance and Occupational Pensions

although this is an informal process. It can

Authority in Frankfurt (EIOPA), depending

then formally amend a legislative proposal

on subject matter. National supervisors feed

via the Council where as a large member

into both the drafting of this legislation via

state the UK wields significant influence,

different committees and stakeholder groups.

as well as via national members of the

The European Parliament and Council

European Parliament. It can also influence

have ‘scrutiny power’ over most of such

the implementing legislation that sits

legislation. The ESAs also have the power to

underneath a Directive of Regulation via the

issue non-binding ‘guidelines’ addressed

European Supervisory Authorities, where the

to member state authorities. These are

UK is represented by the Financial Conduct

adopted following work by the relevant ESA

Authority (FCA) and the Prudential Regulation

committee, on which representatives from

Authority (PRA).

FIGURE 4

Implementing financial services legislation Commission delegated and implementing acts

Supervisory authority technical standards

EU Level

Supervisory authority guidelines

Supervisory authority Q&A industry guidance

Commission reports and review

EU directives transposed into national law

National implementation of guidelines

National level Additional guidance from national regulator

Enforcement

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Shaping legislation: UK engagement in EU financial services policy-making

2.

Case Studies

This chapter looks in detail at five legislative initiatives adopted in the last ten years: the Solvency II Directive, the Alternative Investment Fund Managers Directive (AIFMD), the European Market Infrastructure Regulation (EMIR), the Capital Requirements Directive and Regulation (CRD IV/CRR) and the Markets in Financial Infrastructure Directive and Regulation (MiFID II/MiFIR).

Each case study assesses the extent to which the UK has influenced the legislation to its advantage, the ways it could do this better in the future, and the ability of countries outside of the EU to negotiate and shape policy.

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Case Study 1

At a glance

Solvency II Solvency II adopted by EU institutions in 2009 Omnibus II adopted by EU institutions in 2013 Solvency II and Omnibus II set out capital, risk-management, governance and transparency requirements for (re) insurers New regime has applied since 1 January 2016 Apply to almost all EU insurance and reinsurance undertakings licensed in the EU Solvency II and Omnibus II replace 14 previous directives commonly known as ‘Solvency I’ Seen as ‘Basel III’ regime for insurers

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Shaping legislation: UK engagement in EU financial services policy-making

“Solvency II” on the taking-up and pursuit of

The original Solvency II proposal replaced a

the business of Insurance and Reinsurance

number of existing life and non-life directives,

as adopted in 20091, and the “Omnibus II”

the reinsurance directive and various

Directive2 adopted in 2013 which modifies it,

other insurance-related directives (with

set out the current EU prudential framework

the exception of the Insurance Mediation

for insurers. Together, the Directives create

Directive). Respondents noted that the

a new EU insurance and reinsurance

Solvency II proposal was considered a UK

regime which has applied from 1 January

win in and of itself, as the UK itself had had

2016. The package introduces new capital

a risk based solvency regime for a long

requirements for insurers as well as new

time. Some offered that the reason for the

rules on governance, supervision, reporting

relatively stringent domestic regime in the UK

and disclosure. It is a risk-based capital

ahead of Solvency II was the near-collapse

regime for insurers, similar in concept to

of the Equitable Life Assurance Society in

Basel II, based on three “pillars”: the market

2000, which saw many policyholders lose

consistent calculation of insurance liabilities

their savings and led to a government-

and the risk-based calculation of capital;

administered compensation scheme.

a supervisory review process and thirdly,

Respondents said the UK’s domestic regime

reporting and transparency requirements.

was perceived by other member states

Solvency II applies to most insurers and

to be ‘gold-plating’ existing EU insurance

reinsurers with head offices in the European

legislation – something that could be

Union, including mutuals unless their annual

addressed by the level playing field that

premium income is less than €5 million.

Solvency II was set to create. Several

The roots of Solvency II

(then) UK Financial Services Authority (FSA)

respondents recalled Paul Sharma of the The Solvency II legislation has its roots in

to have written the Directive’s first draft.

both the regular updating of legislation

While Solvency II was being negotiated,

and in the financial crisis. The original

the financial crisis began to profoundly

Solvency II Directive was a major overhaul

affect the balance sheets of insurers. On

of European insurance regulation, which

16 September 2008, the US government

many felt was long overdue. The European

gave American insurer AIG a $85 billion

Commission proposed the legislation to

bailout – the first insurance company to

take account of different developments

be considered of such systemic financial

in insurance, risk management, financial

importance that government intervention

reporting and prudential standards, as well

was inevitable.

as to modernise and strengthen insurance supervision. The proposal was driven forward

As part of the EU response to the financial

when the European Commission concluded

crisis, the ‘de Larosière report’ was drawn

there were widespread divergences in the

up by an expert group chaired by Jacques

implementation of the existing insurance

de Larosière. It stated that insurance

directives across the EU. This was a result

companies are vulnerable to major market

of its aim to ensure the insurance sector

and concentration risks, and tend to be

had a comparable regulatory and

sensitive to stock market developments.

prudential regime to that of the banking

De Larosière considered that the existing EU

and securities sectors.

structure, with its different financial advisory committees to the Commission, was not sufficient to ensure financial stability in the EU and its member states. He proposed

1 Solvency II, also known as Directive 2009/138/EC on the taking-up and pursuit of the business of Insurance and Reinsurance, was formally adopted on 25 November 2009.

2 Omnibus II, also known by amending Directives 2014/51/ EU, 2003/71/EC and 2009/138/EC and Regulations 1060/2009, 1094/2010 and 1095/2010 in respect of the powers of the European Supervisory Authorities (the European Insurance and Occupational Pensions Authority, the European Securities and Markets Authority), was formally adopted on 16 April 2014.

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instead the establishment of a European System of Financial Supervision (ESFS).This recommendation in turn resulted in the establishment of the EBA, ESMA and EIOPA. Changes then had to be introduced to the Solvency II Directive to reflect the changes to the EU legislative process and

the newly established EIOPA. Equally, the

would allow an insurance group’s parent

crisis created a sense that Solvency II had

to guarantee ‘group support’ to members

to be reviewed thoroughly. It highlighted a

of the group which in turn would mean

number of perceived shortcomings in the

that those members would not need to

initial legislation, in particular as regarded

maintain high levels of own funds. The Irish

so-called ‘long term guarantees’.

Commissioner for the Internal Market and

The timing of the Omnibus II proposal

was said to have inserted group support

meant it could be used to address these

at Commission level at the request of

Services at the time, Charlie McCreevy,

changes and shortcomings. A decision

HMT, and ‘forced’ the provisions into the

was made to postpone the application

Commission’s legislative proposal despite

of Solvency II, which made Omnibus II

early opposition from Luxembourg, the

the vehicle for various amendments to

Czech Republic, Hungary and Poland. A key

the original Directive – leading to lengthy

element of the proposed regime was that

negotiations. In particular, the package of

the group supervisor, which was envisaged

so-called ‘long-term guarantees’ became

to be the supervisor in the member state

a major stumbling block. Insurers argued

of the group’s headquarter, would have

that Solvency II capital requirements, in

responsibility for approving capital modelling

combination with low interest rates and a

across the group, so as to avoid multiple

volatile bond market made the offering of

approval procedures. The effect of this was

life-insurance products prohibitively

that supervisors in the larger EU member

expensive. The Commission from its side

states – those where many insurers were

wanted to incentivise insurers to invest

headquartered, would take away power

long-term to match the long-term liabilities

from supervisors in the smaller member states.

of their annuity business, but in a way that addressed risk and gave certainty

A battle in the Council followed where a

to insurance policyholders. Respondents

compromise position had to be hashed out

asserted that member states all had their

ahead of negotiations with the European

own Solvency II wish-list due to differing

Parliament. In response to a number of

national insurance markets. After years of

concerns voiced by the smaller member

negotiation and a change of personnel at

states that group support would leave them

the Commission a deal was eventually struck

with little supervisory power over large cross-

in late 2013. At this point the Directive had

border insurance groups operating in their

been over six years in the making.

states, the French, which held the Council

Group support

negotiations, proposed a compromise text

Respondents asserted that the risk-based

that removed the group support regime

Presidency at the time of the Solvency

approach in Solvency II was formulated

from Solvency II. Respondents described

on the basis of the UK Financial Services

this as a master stroke in which the French

Authority (FSA) approach to capital

traded their assistance in deleting group

requirements. The FSA was said to be

support in return for backing of the French

heavily involved in formulating policy and

position on capital requirements for insurers

participating in preparatory meetings

investing in equities.

at EU level, while the UK Treasury (HMT) ‘undoubtedly’ led UK engagement with

The adoption of the compromise text that

Solvency II overall. It was said that for the

resulted was strongly opposed by Charlie

UK, a key issue during the initial Solvency

McCreevy, who reportedly stated the

II (rather than the later Omnibus II)

Commission would be unable to support

negotiations was that of ‘group support’.

the compromise. The UK, represented at

Group support would have provided

ministerial level by the then-Chancellor

multinational insurance groups with the

Alistair Darling, added to this by pointing out

flexibility of maintaining capital within

the risks of removing group support. While

a group. The regime, proposed by the

the European Parliament’s Economic and

Commission but scrapped by the Council,

Monetary Affairs Committee (the ECON

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Shaping legislation: UK engagement in EU financial services policy-making

Committee) had previously voted in favour

insurers’ assets and liabilities. Respondents

of group support, it was under pressure to

noted that since fixed income, particularly

come to an agreement with the Council

government debt, makes up the vast

before the European elections in the summer

portion of insurance portfolios for long-term

of 2009 and a deal was eventually struck

business, insurers worried that the debt crisis

between the two institutions in March 2009.

would have a destructive impact on their

Within the deal struck, respondents noted

balance sheets. Insurers argued that as

the UK was successful in excluding pensions

assets used to back long-term liabilities are

from the scope of Solvency II, which was

often held to maturity, bond market volatility

said to be the result of an industry-led effort

would have little material impact on their

brokered by Insurance Europe3. The effort

ability to fulfil their long-term obligations to

resulted in a deal on pensions in which

policyholders – and thus that the Solvency II

the French, German and UK systems were all protected. Whilst the UK essentially lost

‘market consistent valuation’ did not always adequately reflect their actual risk exposure.

on the issue of group support, it assured a

It was said this problem was made more

provision was included stating that the idea

apparent by EIOPA’s QIS5 impact assessment,

would be revisited again at a later stage.

which provided quantitative input for the Commission’s proposal on Solvency II

In addition, respondents asserted that

implementing measures. The assessment,

getting the idea into the Commission’s

along with heavy industry pressure, was

proposal in the first place as done by

said to have pushed the ECON Committee

McCreevy, could be seen as a successful

(responsible for the European Parliament’s

outcome given the sizeable opposition.

position) as well as the Council in which the

In addition, respondents pointed to the

member state position was being written,

fact that the group support loss was to a

to include so called ‘long-term guarantee

large extent a result of the financial crisis

measures’ in their respective versions of

context, which created more concerns

the Commission’s proposal. The aim of the

around bank branches for home states and

measures was to address the impact of

an unfavourable political environment for

market volatility on insurers’ balance sheets.

the idea. Respondents noted the UK fared better in the Omnibus negotiations, arguably

However, the choice to introduce a

the more important as they significantly

complex technical remedy led to highly

altered Solvency II in a difficult post-financial

politicised measures that became subject

crisis context. Respondents said the idea

to heavy lobbying as they were being

of a ‘matching adjustment’ was largely

drafted. Respondents noted member

championed by UK insurers, which needed

states often backed the views of the

to find a solution to domestic market

bigger players in their domestic insurance

troubles. The adjustment, whilst opposed by

market. Respondents recalled that when

France and Germany, was included in the

the Council and Parliament entered into

final package on long-term guarantees – a

trilogue negotiations, the technical nature

major coup for the UK.

of the long-term guarantee measures being worked on and their potential disruptive

The Long-Term Guarantees package

impact on the insurance industry pushed

Respondents explained that the 2010

the co-legislators to request assistance

Eurozone crisis laid bare the need to address

from EIOPA, which was asked to publish an

market volatility on Solvency II balance

assessment of possible Long Term Guarantees

sheets. The Solvency II text, which was yet

measures. Some respondents asserted that

to enter into force at this stage, introduced

EU legislators were increasingly worried

the ‘market consistent’ valuation of

about the potential disruptive effects of the

3 Pensions are not within scope of Solvency II capital requirements. It was intended that these would be addressed in the subsequent IORP Directive. Lobbying on this issue continued after Solvency II was finalised and ultimately IORP includes governance requirements but no corresponding capital regime.

also on insurers’ long-term investments in

legislation in terms of financial stability, and

18

the EU economy. The following June, EIOPA published a set of recommendations which retained some of the measures proposed

by trilogue parties and introduced some

‘gaming’ the new measures for maximum

alternatives. Respondents recalled the report

benefit. Respondents recalled how in the

was eagerly awaited and, just as with QIS5,

final rounds of the Omnibus II trilogues, they

it placed a lot of responsibility in the hands

managed to convince parties to insert

of the relatively new EIOPA. Some argued

provisions that would allow EIOPA to monitor

the process elevated EIOPA’s role from

the use of the measures at European level,

providing technical advice on implementing

whilst national competent authorities were

measures, to broader advice on the content

given more discretion to approve the use of

of the legislative text. This gave EIOPA

the measures at national level. A late night

unprecedented influence over the political

deal on Omnibus II was finally agreed after

process. The report paved the way for the

eight hours of negotiation on 13 November

November 2013 agreement on the Directive

2013. While the deal struck represented both

as a whole but a number of EIOPA’s proposals

pros and cons for the UK, the regime was

were watered down – some significantly –

described by respondents as overall positive

through intensive member state bargaining

for the UK, as its own risk-based regime had

and industry lobbying. The resulting package

largely become the European standard and

of long-term guarantee measures in Omnibus

included the matching adjustment provisions

II aimed to ensure that short-term market

championed by the UK.

movements were appropriately treated with regards to insurance business of a long

Third countries

term nature. Amongst others, the package

The Solvency II Directive has sought to

included the UK-preferred ‘matching

account for the international nature of

adjustment’ that was seen as vital to its large

the insurance industry. Under Article 172

annuity business.

of Solvency II, the European Commission can decide on the equivalence of a third

The matching adjustment was a measure

country’s solvency regime applied to the

that would allow firms to acknowledge that

reinsurance activities of undertakings with

where they have a portfolio of bonds or

their head office in that third country. A

bond-like assets with durations and cash

positive equivalence determination allows

flows that closely match a specific portfolio

reinsurance contracts concluded with

of liabilities, they are primarily exposed to the

undertakings having their head office in

risk of default on these assets – but not to

that third country to be treated in the same

the volatility in market prices. The adjustment

manner as reinsurance contracts concluded

was introduced following pressure from UK

with EEA firms. Article 227 stipulates that

and Spanish industry. This was seen as a

equivalence for third-country insurers

positive outcome for the UK. France fought

part of groups headquartered in the EEA

its own battles and pushed for an ‘extended’

can be assessed. A positive equivalence

matching adjustment which would include a

determination allows such groups to use the

wider set of assets and liabilities, and looser

local calculation of capital requirements

criteria overall. But this was rejected by EIOPA

and available capital under the rules of the

in its long-term guarantees assessment, which

non-Union jurisdiction rather than calculating

made it difficult to reintroduce in the final

them on the basis of the Solvency II Directive.

trilogue agreement. What was included, as an alternative (and mutually-exclusive)

Article 260 in turn sets out that the

option to the matching adjustment, was the

Commission may adopt a decision as to

so-called ‘volatility adjustment’: a permanent

whether the prudential regime for the

modification to the risk-free curve used to

supervision of parent undertakings from third

calculate the present value of liabilities,

countries with activities in the EEA (third-

which could be applied to a wider range of

country insurance holding companies, a

liabilities. National Supervisory Authorities, who

third-country insurance undertakings or

had fed into the EIOPA long-term guarantees

third-country reinsurance undertakings) is

assessment, were concerned their proposals

equivalent to that laid down in Solvency

were being modified substantially by trilogue

II. If the third country’s rules are deemed

parties and that this would result in insurers

equivalent, EEA supervisors will, under certain

19

Shaping legislation: UK engagement in EU financial services policy-making

conditions, be able to rely on the group

Swiss input on EU equivalence mechanisms.

supervision exercised by a third country. This

The Solvency II Directive and further

frees third-country international groups from

directives amending Solvency is included in

being subject to dual group supervision. The

Annex IX of the EEA Agreement. Aside from

equivalence mechanism was described by

Switzerland via ‘equivalence’, Solvency II

some respondents as a key achievement for

thereby applies to Norwegian, Icelandic and

the UK as the City of London would be the

Liechtensteinian insurers and reinsurers, who

main beneficiary of the regime and allow

may provide insurance and reinsurance

it to maintain its status as an international

across the Single Market.

centre for insurers. Respondents asserted that facilitating non-European business and

However, the Annex does not include the

enabling London-based insurers to purchase

delegated act containing the Solvency II

reinsurance from third countries such as

implementing provisions. This is because

Switzerland and Bermuda, and this being

the implementing provisions depend to a

counted appropriately towards the Solvency

large extent on the power of the ESAs; in this

II capital requirements, was therefore key. This

case EIOPA. Respondents said that under

would require an equivalence mechanism

Norwegian constitutional law, financial

whereby third countries could be recognised

system supervision cannot be handed over

as equivalent jurisdictions.

to a non-EU body and that while Norway seeks to update the EEA Agreement, it has

The first equivalence decisions were for

so far not succeeded in this. Whilst the EEA

Switzerland and Bermuda, both of which

Agreement thus includes various pieces of

were taken ahead of the application

EU financial services legislation, it cannot

date of Solvency II so as to avoid market

be used for accessing the EU market, which

disruption. ‘Provisional’ equivalence was

means EEA signatories in the case of insurers

granted to Australia, Brazil, Canada, Mexico,

are subject to third country provisions and

the United States and Japan for a maximum

equivalence decisions rather than availing

duration of ten years. Provisional equivalence

of simplified access via the EEA Agreement.

can be granted to third countries that do

As noted previously, the power of such

not yet meet all criteria for full Solvency

equivalence decisions rests largely with

II equivalence, but where an equivalent

the European Commission, which is under

solvency regime is expected to be adopted

no obligation of granting equivalence but

and applied by the third country within a

rather must take into account the interests of

foreseeable future. It must be noted, however,

the Union.

that the Commission is required to review its equivalence decisions to take into account

Lessons learnt

any changes to the Solvency II prudential

The Solvency II legislation, upon completion,

regime or the prudential regime in the third

was over ten years in the making. While its

country or any other change in regulation

outcome represented both positives and

that may affect the equivalence decision.

negatives for the UK, the package benefited

The power on equivalence thus rests largely

from significant UK influence in terms of

with the Commission, which decides the

the drafting of the original proposal. Other

criteria for assessing whether the prudential

UK achievements included the inclusion of

regime in a third country for the supervision

provisions in the final package that permitted

of groups is equivalent to that laid down in

insurers to return to the market after technical

Solvency II.

insolvency; significant influence over the first counter-cyclical provisions in Union financial

Respondents noted that the Swiss worried

services legislation; the treatment of letters

that Solvency II would set a global standard

of credit as Tier 1 eligible capital and the

Switzerland would be unable to meet and

exemption of pensions from the legislation.

that would impact big Swiss (re)insurers. They noted that whilst an equivalence decision

20

Solvency II as a case study offers a number of

requires Swiss cooperation, there is no

lessons. The first and perhaps obvious includes

institutionalised dialogue that allows for

patience and continued engagement, given

that the legislative process was protracted and significantly delayed over time. The

‘right’, alienating others with an inflexible, principled approach. Upsetting the French

Solvency II and Omnibus II negotiations

in this way and cornering the smaller

demonstrate that concerted efforts can

member states led to a coalition that

suspend a legislative process if legislation is

blocked group support, a major UK ask.

viewed as highly significant and potentially disruptive for a particular industry. This

Less obvious lessons would be that in a

made Solvency II into a long game. Few UK

post-Lisbon world, highly technical financial

officials would have thought in five, let alone

services legislation is shaped by national

ten-year time frames at the legislation’s

and European regulators to a large extent.

outset. Yet between the Commission’s initial

In the case of both Solvency II and Omnibus

Solvency II proposal and its implementation

II, EIOPA and its predecessor CEIOPS

in 2016, over ten years lapsed. A first lesson

were influential outside of their regular

would thus be setting long-term goals and

Level 2 role. EIOPA’s 2011 QIS5 study was

managing a national objective consistently

crucial for the push towards tailored long

through Level 1, Level 2, ESA guidance and

term guarantees measures and its 2013

possible Commission revision with continued

Long Term Guarantees Assessment was

engagement and insofar as possible,

instrumental to the final trilogue agreement

staff with institutional memory. One

on the package. This suggests that national

respondent asserted the ‘long game’

regulators’ active involvement with the

gets played increasingly, which presents

legislative process at the European level,

challenges as well as more opportunities

for instance through taking up senior

to shape legislation.

positions and other secondments with the ESA, leading ESA working groups,

More obvious lessons are the importance

the participation of senior officials in

of strong officials at all levels in HMT and

Commission comitology committees, an

the FCA, and the continuity of personnel

active interest in scrutinising draft Level 2

to see through the brokering of deals. The

measures and contributing towards data

replacement of two then-FSA representatives

collection exercises is highly valuable. By

in Brussels was seen as undermining the UK

extension, it could be argued that data in

efforts to gain key concessions during the

a post-Lisbon EU is an extremely powerful

Solvency II negotiation. Focusing efforts on

weapon. The influence of data in EU

integral areas was also an important lesson,

financial services legislation has grown with

with respondents pointing to the organisation

the creation of the supervisory authorities

and discipline of Germany’s Federal Financial

and those who control data would seem

Supervisory Authority (BaFin) in focusing on a

to control the direction and pace of travel

limited set of issues, advocating those early,

of legislation to a large extent. In a post-

liaising with industry allies and maintaining

financial crisis world, EU legislators are

pressure throughout negotiations. The CRO

increasingly concerned with the potential

Forum, as well as Insurance Europe, were said

disruptive and ‘cumulative’ effects of

to be particularly influential at different stages

financial services legislation on jobs and

in the process, which underlines the potential

growth. Supporting one’s case – whether

value of industry coalitions.

as a national policy maker, national regulator or industry participant – with data-

Another of the more obvious take-aways from

backed arguments and mobilising data

Solvency II is the benefit of national officials

submissions would appear to be invaluable

in key positions, as the power wielded by the

in influencing legislation.

UK Rapporteur for the European Parliament (who stood firm on the matching adjustment) during Solvency II negotiations demonstrates.

Respondents also pointed to the importance of political sensitivity and asserted that at times throughout the Solvency negotiations, the UK was too convinced its approach was

21

Shaping legislation: UK engagement in EU financial services policy-making

Case Study 2

Alternative Investment Fund Managers Directive

At a glance

AIFMD

Adopted by EU institutions in 2011 Applies to managers of AIFs, not directly to funds themselves Creates an EU authorisation and supervisory regime for AIFMs Introduces a European passport for authorised AIFMs Introduces capital, governance and transparency requirements for authorised AIFMs Maintains national private placement regimes for non-EEA AIFMs

22

Directive 2011/61/EU on Alternative Investment

AIFMD was not created in a complete

Fund Managers (AIFMD) was formally adopted

legislative vacuum. Prior related initiatives had

on 01 July 2011. The legislation was the EU’s first

included the Commission’s 1999 Financial

regulatory response to the financial crisis and

Services Action Plan, which led to the revision

aimed to provide a comprehensive regulatory

of the UCITS (mutual funds) Directive, as well as

regime for the EU’s hedge fund industry. The

providing the basis for the MiFID I Directive, both

impetus for the legislation came from the

of which had impacted the industry. Then in

French and German governments, who

2005, the Commission published a Green Paper

enjoyed the backing of much of the European

on the enhancement of the EU framework

Parliament. Despite initial scepticism from the Commission, changes in the EU political

for investment funds. This was followed by a ‘White Paper’ which made proposals for the

environment triggered by European elections

removal of marketing and sales restrictions

and the end of the Commission’s mandate,

of hedge funds’ products throughout the EU,

along with emerging international standards,

as well as removing national barriers to the

forced the Commission’s hand. Legislative

private placement of financial instruments with

proposals for the Directive were hurriedly

institutional investors and eligible counterparties.

produced and published in April 2009.

While these could be seen as the first steps

The roots of AIFMD

towards AIFMD, the initiatives appeared to be

Alternative investment is the collective term for

focused more on facilitating the integration

a set of organisations from the private equity,

of the EU financial services industry than

venture capital and hedge fund industries. The

mitigating particular risks stemming from

Commission intended to regulate this broad

it. However, support for EU-level regulation

collection of fund managers through a single

of hedge-funds was growing in France and

‘one-size-fits-all’ instrument.

Germany. In both countries, the deregulation of financial services throughout the 1990s and

Despite limited previous EU interest in the

2000s led to a political debate about the risks

hedge fund industry the ‘alternative investment’

of a globalising market in capital and financial

sector is where legislators directed their

services.

attention in the first instance following the onset of the financial crisis. A UK Conservative MEP

This pushed Angela Merkel, in her early days

closely involved in the negotiations likened

as Chancellor, to call for the greater oversight

the Commission approach to the chaos of a

of hedge funds, which was made a key

bar fight: “if a fight breaks out in a bar, you

agenda item for the 2007 G8 summit hosted

don’t hit the person who started the fight, you

in Germany. France backed these efforts,

hit the person you’ve always wanted to hit.

with the UK and US as well as the European

There were a lot of people who wanted to hit

Commission at this stage, in opposition.

hedge funds and private equity”. Interviewees

What resulted was an agreement by the

recalled several member states, and even

G20 to strengthen the national oversight

government officials in Germany, France

and supervision of the industry, which was

and Greece, with negative experiences of

reiterated separately by EU finance ministers

the industry. The drive from the Directive was

in 2007. Angela Merkel did not leave this

primarily the backlash against this.

agreement as it was, however, and renewed

23

Shaping legislation: UK engagement in EU financial services policy-making

her calls for EU regulation not long afterwards.

The UK then, as before, opposed these calls.

The resulting proposal was widely criticised, both by the industry and EU and national policy makers.

However, the financial crisis, which had really set in by 2008 with the collapse of

The draft covered the management,

Lehman Brothers, shifted the political context

administration and marketing of alternative

dramatically. This mood was captured by

investment funds. In the proposal this covered

ex-Danish Prime Minister Poul Nyrup Rasmussen

hedge funds, private equity funds, commodity

MEP, president of the Party of European

funds, real estate funds, debt funds, energy

Socialists, whose parliamentary report

and carbon funds and infrastructure funds.

demanding a Commission legislative proposal

In order for AIFMs to be authorised, the

to regulate the private equity and hedge fund

proposal set out that they would need to

industry received Parliament-wide support.

only undertake permitted activities and meet

The UK initially disregarded the report, with

capital, organisational, remuneration and

the hedge fund industry expecting the idea

risk and liquidity management requirements.

of direct regulation to be dismissed by the

The Commission draft was criticised for failing

Commission.

to reflect the nature of the EU market. In

Internationally, the G20 Summit in Washington

with provisions on custodians restricted investor

in November 2008 had started to focus on

choice to only those fund managers with a

particular, ‘gold plating’ of the G20 principles

proposals for enhanced transparency and

bank which was not standard practice in

best-practice in the hedge-fund industry, on

Japan, and other key jurisdictions. This would

which momentum increased at a later London

have caused a restriction in investor choice

summit. While the UK was alarmed by these

and a knock-on concentration of risk in a few

international developments, it engaged in

compliant funds. While the implications of

them so as to seek a level-playing field with the

this were immediately obvious to the industry,

US and front-run potential EU legislation.

interviewees pointed out that the Commission had seen so little input from industry

This did not work as planned. Aside from the

participants that a lack of understanding of the

European Parliament, Commission President

consequences of new provisions was inevitable.

Barroso had now started championing an EU regulatory initiative proposal, in an

During the - initially extremely reluctant -

apparent deal to secure French, German

negotiations that followed, those countries with

and Socialist support for his reappointment as

a substantial fund management industry such

Commission President. Commissioner McCreevy

as the UK, Ireland and Luxembourg fought out

was pushed to defend a Commission

several legislative battles. Despite tense political

Communication resulting from the Washington

brokering and continued industry opposition,

G20 agreement which pledged not only to

agreement on the Directive was reached in

transpose G20 transparency best-practice,

2010. AIFMD has been applied since 2014.

but also to introduce a harmonised regulatory and supervisory framework for alternative

Organisational requirements

investment funds in the EU as a matter of

Once the UK understood that there was no

priority. Throughout 2008 McCreevy had

way to avoid the legislation in its entirety, the

claimed that AIFs would not be regulated at EU

negotiating stance shifted towards ensuring

level.

new requirements were accompanied by

The Commission’s AIFMD proposal that followed

The UK’s engagement on this issue was both

was framed by the European Commission

strategic and principled. Principled in that

and the European Parliament as an essential

the UK felt it was basic fairness for EU level

improved market access for compliant AIFMs.

24

response to the financial crisis. Due to the highly

legislation to open up access to the EU market

politicised circumstances, it was drafted in

for those meeting the required standards; and

haste over a six week period. This meant that

strategic in that framing the debate in this way

no impact assessment was conducted, and

allowed the UK to use those provisions it could

even internal legal checks were rushed through.

not block as a bargaining chip. Interviewees

recalled a small, but well organised coalition of

choice, as increased costs would result in a

those member states with well-developed AIF

drop in the number of funds available.

sectors (the UK, Luxembourg and Ireland) who simultaneously called for an open EU market,

For non-EU funds and fund managers, the

while pushing back on the most stringent

answer lay in maintaining existing NPPRs. This

regulatory requirements. The UK’s negotiating

mechanism would allow fund managers

strategy led to some notable successes in

to continue to market AIFs that were not

the removal of the quantitative leverage

authorised under AIFMD. Initially opposed

cap on funds, and proportional revisions of

by the German and French governments, a

disclosure and transparency requirements.

compromise was finally reached, allowing

Interviewees also pointed out the important

existing private placement regimes to remain

role played by UK industry in avoiding stringent

in place until 2018. Interviewees recalled an

depository requirements. In the wake of the

unprecedented intervention from the US on

collapse of Lehman Brothers, the French and

this issue. Concerned by EU developments

Spanish governments looked to build on

the US Treasury Secretary, Timothy Geithner,

Commission proposals requiring assets to be

wrote directly to the French Commissioner for

valued and held by a depository bank. The

the internal market, Michel Barnier, and other

French, in particular, were hoping to add a

policy makers, warning that the proposed

location restriction to prevent funds from using

treatment of third country funds under

depository banks in other member states.

AIFMD would cause a rift between the US and the EU on financial regulation. While the

Ultimately the French failed to introduce

Commissioner reacted angrily, taking to the

location requirements. Some interviewees were

Brussels media to refute Geithner’s concerns,

keen to point out that although industry were

those involved in Council negotiations

unhappy with the new depository requirements

recall a sharpening of focus amongst

this still constituted a positive outcome for the

some member states on the implications

UK as considerably more restrictive provisions

of a restrictive third country regime. The

had been avoided. This was in keeping with

agreed regime has caused some difficulty

the UK’s overall approach to the legislative

to AIFM’s who delegated the management

negotiations. Rather than fighting to have single

of their funds to non-EU managers, given the

provisions removed, the UK focused on ensuring

confusion around the status on non-EU AIFs,

the regime was something industry could work

but ultimately much greater market disruption

with. While depository requirements were fairly

was avoided.

cumbersome, avoiding location requirements meant no funds would be prevented from

The UK and its allies also invested significant

carrying on their business.

attention in the EU-passporting regime. This

Passporting and national private placement regimes (NPPR)

one EU member state can carry out activity

On the flip side, the UK was also successful

home state authorisation. The UK were keen

was a process whereby a firm authorised in in another member state on the basis of its

in negotiating workable market access

to ensure market access for funds, but met

provisions. With London acting as host to

opposition from member states opposed

a large number of funds using the UK as a

to non-EU AIFMs gaining market access in

base to access European markets, the UK

this way. The final compromise saw the UK

needed to ensure that both EU and non-EU

accept a delay in the introduction of EU

funds and fund managers continued to be

passports for non-EU funds in return for the

able to operate. UK fund managers are also

temporary maintenance of NRRPs.

responsible for the launch of the majority of new European investment companies, but

Another significant UK victory was securing

the funds themselves are often domiciled

the involvement of ESMA. The compromise

outside the EU. The UK was keen to avoid

gave a significant role to ESMA in drawing up

any provisions restricting managers’ ability to

the requirements that funds would have to

launch and market offshore funds. This was

fulfil and resolving disputes between national

seen as an unnecessary restriction on investor

regulators over the eligibility of a given fund.

25

Shaping legislation: UK engagement in EU financial services policy-making

Interviewees pointed to the key role place by

Lessons learnt

FSA officials in reaching the deal. The FSA’s

In extracting lessons from the UK’s experience

successor, the FCA, would go on to play a key

on AIFMD, the unique context in which the

role in drawing up the requirements at for AIFs

negotiations took place should be noted.

at Level 2.

AIFMD was formulated at the height of the crisis, despite venture capital and private

Although the compromise agreement was a

equity in essence no more than a side

relative win for the UK, the passporting regime

show to the crisis’s real protagonists; the

has not been a resounding success. NRRPs

credit institutions. In a sense, AIFMD was the

have proven critical to minimising disruption

product of unfortunate timing with the AIF

to the London market but in practice the

industry caught in the cross-fire between

take-up of passports by EU-AIFs has been

failing institutions and arguably, trigger-happy

low. Although negotiators in 2011 could not

regulators. Securing amendments to the

have foreseen it, this could yet play into the

Commission proposal was an uphill battle.

UK’s hands. With the Commission’s renewed

Given that few member states had a hedge

focus on building non-bank finance in the EU,

fund and private equity industry as big as that

as part of the Capital Markets Union initiative,

in the UK, it was hard to persuade others that

the issue is due to be reopened this year.

regulating hedge funds and private equity

Led by the British Commissioner for Financial

would have detrimental effects in Frankfurt

Stability, Financial Services and Capital

or Paris. Domestically, member states were

Markets Union Jonathan Hill, the Commission

focused on the particular problems of their

will begin consulting on the barriers to the

own jurisdictions and national industries, but

cross border marketing of funds. It is highly

were still happy to lash out at a foreign industry

likely to result in a revision of the AIFMD

at the EU level.

passport regime, giving the UK a chance to revisit market access, with the backing of

Initially the UK focused for too long on trying to

a supportive Commissioner and with some

push the legislation back, rather than actively

distance from the financial crisis.

engaging in the process. Rather, respondents said the UK should have sought earlier on to

Even within the current AIFMD framework,

shape the draft Directive into the best version

a review is already underway. In July 2015,

possible within the available parameters and

ESMA published its advice on the application

address the technical inadequacies within the

of the EEA marketing passport under AIFMD

Commission’s approach. In the Commission’s

to non-EEA managers and funds, and its

rushed attempt to draft technically sound

opinion on the functioning of the passport for

legislation, the UK lending its expertise to

EEA AIFMs and NPPRs. Although this advice

improve the proposal earlier on could have

is the first step in opening up the European

potentially resulted in a text with fewer

market to non-EU funds, it will also be the first

fundamental flaws.

step towards removing some NPPRs. Within the EU, this could be significant for London-

During Council negotiations, the UK’s

based foreign funds providing much easier

engagement became more nuanced. The

access to the European market.

UK’s successes on key issues demonstrated that an EU member state acting alone

Were the UK to leave the EU, London would

26

will struggle to have an impact at EU level

no longer be a suitable base for managers

but that a coalition, as small as that of two

hoping to market their funds across the EU.

member states, can catalyse a discussion

Along with all UK authorised fund managers,

and set the agenda. The stalled start in the

they would have to look for authorisation in

UK’s engagement necessitated a patchwork

Luxembourg or Dublin in order to make use of

approach to negotiations that could provide

this increased market access. Needless to say,

a lesson even for less fraught negotiations. The

if the UK were no longer an EU member state,

UK had historically fought hard on key issues

this transition would not take place under

in pursuit of ideal, or technically accurate

a UK Commissioner, nor with any role for UK

solutions, but faced with such a messy draft

negotiators in drafting the rules.

there was a marked shift in UK focus. The

priority became ensuring that the Directive

the ultimate drafting of technical provisions.

would be workable, rather than that it

Such was the case with the compromise

was coherent.

that required ESMA to draw up certain requirements that funds would have to fulfil

A lesson in a similar vein is the power of

and the power it was attributed to resolve

temporary derogations. The temporary

disputes between national regulators over

derogation on NPPRs, which will remain in

the eligibility of a given fund. The FSA was

place until 2018, and is then subject to review,

said to have played a key role in reaching

has protected the UK industry from the most

this deal, with the FCA later playing an

detrimental impacts of the weak third country

important role in drawing up the requirements

regime. While an entire exemption is difficult to

themselves. While resolving an issue in such a

achieve, review clauses can have materially

way creates a less political and more neutral

the same effect. Constructing a negotiating

setting, it equally provides new entry points

position on this can also be easier, as the

to influence the provisions in question, via

effects of new legislation would take some

formal consultation and working groups as

time to crystallise. Temporary derogations can

well as informal contact between national

also lead to permanent ones and at least can

regulators. At the same time, this new forum

serve to push the decision on the long term

for negotiation has created an additional

solution to a less politicised context. The 2018

series of processes that can have an impact at

review of private placements will take place

the national level and must be paid adequate

in a very different environment to the 2011

attention to.

negotiations, with the Commission looking to build cross-border capital markets and to roll

AIFMD also highlights the difficulties faced

back some of the more onerous post crisis

by non-EU countries in accessing EU markets.

legislation. This will only serve to aid industry

While a workable solution was found for

and the UK’s lobbying on the issue.

the ‘third-country regime’, this was clearly

Another, albeit obvious, lesson is that of the

quite happy to gold plate international

not prioritised by the Commission, who were importance of cooperation with industry

requirements and adopt legislation at odds

and encouraging its mobilisation in adversity.

with the approach taken in other jurisdictions.

Throughout AIFMD, private equity players,

AIFMD has also shown up significant

hedge fund managers and service providers

deficiencies in the EEA Agreement, which

targeted both co-legislators, with some

call into question the viability of access

positive results. Very often, the ‘real life’

arrangements for EEA Agreement signatories

context of proposed legislation and the data

in the short term.

that can be provided by industry is invaluable to regulators, who often have no detailed knowledge of the particulars of the workings of an industry. In the case of AIFMD, once it became engaged, the industry was able to add to the negotiating position of UK officials and provide valuable ammunition for forging compromises.

The power and usefulness of implementation measures also became apparent during AIFMD negotiations. With the establishment of the ESAs, the Lisbon changes gave new impetus to technical, Level 2 legislation. This created opportunities, as it meant that when AIFMD negotiations got stuck, a relatively uncontroversial breakthrough could be forced by moving an issue into the remit of ESMA for further examination, consultation and

27

Shaping legislation: UK engagement in EU financial services policy-making

Case Study 3

European Market Infrastructure Regulation

At a glance

EMIR

Adopted by EU institutions in 2012 Implements 2009 G20 commitments on OTC derivative market reforms Applies to all counterparties to OTC derivative contracts Requires counterparties to report OTC derivative transactions Obliges some counterparties to centrally clear eligible contracts Obliges some counterparties to margin contracts not centrally cleared Defines rules for authorisation and supervision of central counterparties (CCPs) and trade repositories

28

Regulation 648/2012 on OTC derivatives,

Less than two months later G-20 leaders

central counterparties and trade repositories

including then-UK Prime Minister Gordon

(as known as the “European Market

Brown and then-Commission President

Infrastructure Regulation” or EMIR) was

Jose Manuel Barroso met in the US city of

formally adopted on 04 July 2012. The

Pittsburgh. Annexed to a summit statement

legislation has its roots in both the voluntary

focussed on responses to the Global Financial

clearing agreements for credit derivatives

Crisis was a specific set of commitments

agreed by market participants in June 2009

to reform OTC derivative markets. These

and the commitments to reforms of the

commitments state that all standardised OTC

global “over the counter” (OTC) derivatives

derivative contracts should be traded on

markets agreed by the Group of Twenty

exchanges or electronic trading platforms

(G20) leaders, including then-UK Prime

where appropriate, should be cleared

Minister Gordon Brown at their September

through central counterparties (CCPs) by

2009 summit in Pittsburgh, USA.

end-2012, and should be reported to trade

The roots of EMIR

OTC derivative contracts not cleared by a

The voluntary clearing agreements were

CCP should be subject to higher regulatory

repositories. The commitments also state that

driven by the European Commission, which

capital requirements. The commitments

had become an enthusiastic proponent of

also direct the Basel-based Financial

central clearing following the collapse of

Stability Board (FSB) to track and assess

Lehman Brothers and the mixed success of

implementation of the commitments by

efforts to resolve the failed company’s OTC

G-20 members.

derivative positions. The Commission saw central clearing as an important means to

Thus EMIR was conceived as a means

limit contagion amongst derivative market

to provide a legislative basis for both

participants and reduce systemic risk. It

the voluntary clearing obligation and

identified the credit derivative markets

the commitments made by the member

as those most in need of central clearing

states (both those like the UK that were

in the near term. Wielding the stick of

G-20 members as well as member states

higher regulatory capital requirements

collectively as represented by the Council

for derivative positions, the Commission

of the EU). The Commission began the

in October 2008 invited credit derivative

preparatory work for this legislation in

market participants led by the International

October 2009, setting out in detail its

Swaps and Derivatives Association (ISDA) to

proposed ‘future policy actions’ in a

agree to a ‘voluntary’ clearing obligation

communication. Interviewees noted little

for credit default swaps. Market participants

opposition to these future policy actions,

quickly agreed and over the following eight

aside from some disquiet regarding the

months an expert group comprising market

requirements applicable to ‘non-financial’

infrastructure, sell and buy-side market

market participants. The real disputes started

participants and chaired by the Commission

when the Commission began to detail

devised a clearing obligation for index credit

requirements for CCPs and sought to include

default swaps. The clearing obligation was

a provision on access to clearing services,

published in July 2009 with immediate effect.

which would have direct effect.

29

Shaping legislation: UK engagement in EU financial services policy-making

CCP access to discount window

Access to clearing

Central clearing as a means of reducing

Article 3(1)(b) TFEU grants the Union exclusive

systemic risk works to the extent that

competence for competition rules “necessary

CCPs are highly unlikely to fail. This in turn

for the functioning of the internal market”

requires that they are heavily capitalised

and a competition objective is evident in

and subject to close and continuous

most legislative proposals adopted by

prudential supervision. There are various

the Commission. So it was with the EMIR

means of capitalising CCPs including margin

proposal. For the OTC derivative markets

requirements, default fund contributions

the Commission’s specific competition

from clearing members and emergency

objective identified by interviewees was to

liquidity facilities. EMIR requires CCPs to

target the bundling of trading and clearing

maintain financial resources to cover losses

services and to force competition amongst

that may exceed the margin and default

CCPs. The Commission services were at

fund contributions that it collects from

the time well aware of complaints regarding

clearing members. The legislation is not

non-discriminatory access to clearing

prescriptive as to the nature or quantum of

aimed at inter alia market infrastructure

these other financial resources but it was

groups offering both trading and clearing

not always so. Interviewees report that the

in exchange-traded derivative contracts

European Central Bank (ECB) and other

and index providers owned by market

members of the Eurosystem advocated

infrastructure groups.

more onerous requirements on funding including that CCPs have access to shortterm, low-interest funding from central banks – known as the “discount window”. These

The Commission considered that if it was to propose legislation requiring counterparties to centrally clear derivative contracts in

central banks in particular wanted CCPs to

line with the G20 commitments, it had to

have access to such emergency liquidity in

ensure that CCPs could not discriminate

euros and the denominating currencies of

against execution venues and deny access

any other derivative contracts in which the

to clearing services. It could do this through

CCP offered clearing. As a requirement this

prescriptive provisions in the EMIR legislation

was not especially problematic for CCPs

requiring member state governments to

authorised in France or Germany, which

closely supervise the provision of clearing

held banking licenses and could access

services and ready its competition teams

ECB facilities. However, it posed a significant

to investigate the complaints of market

problem for CCPs authorised in the UK.

participants. Or it could arm market

These CCPs were not banks and would

participants directly. It did the latter, including

have no means of accessing central bank

in the EMIR legislative proposal a one

facilities denominated in euro or US dollars.

sentence requirement at Article 5 that CCPs

A requirement of access to the discount

authorised to clear eligible OTC derivative

window would at least disadvantage

contracts shall accept such contracts for

UK CCPs in clearing euro-denominated

clearing, regardless of the venue in which

contracts and could at worst preclude

those contracts are executed. The simplicity

them clearing such contracts entirely. Alert

of this sentence belied its prospective

to these risks, HMT and the Bank of England

impact. The provision met the conditions of

opposed the requirement. Interviewees point

the CJEU ruling in Van Gend en Loos and,

to a late-stage, high-level intervention by

if adopted, would have direct effect. This

HMT to secure amendments to the legislative

means that market participants did not

proposal removing the requirement shortly

have to wait on the Commission or national

before it was adopted by the Commission in

regulators to investigate and prosecute CCPs

September 2010.

for discriminatory denial of clearing services.

Market participants could enforce their right

The provisions of CCP funding and the Article

to non-discriminatory access to clearing

5 requirement on non-discriminatory access

services directly through national courts.

to clearing mark two strong outcomes for the UK Government in the pre-legislative phase.

30

The draft legislation remained hotly contested

through a legislative review lasting almost

decision was eventually granted to

two years with interviewees noting victories

Switzerland in November 2015, which resulted

for those opposing non-discriminatory access

in granting a formal recognition of SIX x-clear

to clearing in both preventing application

Ltd by ESMA in March 2016.

to exchange-traded derivatives and diluting away the direct effect of the provision

EMIR implementing measures

by amendments. Prompted by UK market

Much of the detail in EMIR is set out in the

infrastructure groups and UK subsidiaries

various Commission Delegated Regulations

of the large dealer banks, HMT and the

adopted since December 2012. With so

Financial Services Authority (FSA) teams

much detail in these legal instruments it

built informal coalitions of support with

is unsurprising that the implementation

representatives of member states including

procedure saw much of the same active

The Netherlands, Denmark, Finland and the

lobbying by member state governments on

Czech Republic. These informal coalitions

behalf of their favoured market infrastructure

often faced similar informal coalitions bringing

and market participants. This time round and

together the representatives of German,

with all on eyes on the nascent ESMA, it was

France, Italy and Spain with periodic support

national regulators promoting positions and

from other southern European member state

agreeing coalitions with a view to shaping

governments. Interviewees concur that this

key legal instruments. Interviewees recalled a

latter coalition of member states lobbied

number of contentious debates on the draft

defensively but effectively on scope and

regulatory technical standards prepared by

access provisions.

ESMA. Yet none emphasises the utility of wellaligned, focussed member state lobbying

Qualifying Central Counterparties

quite like the provisions on eligible collateral

Non-EU, non EEA countries are subject to

set out in Commission Delegated Regulation

a ‘third country regime’ under EMIR. This

153/2013 on requirements for CCPs. This

means that Switzerland, for example, will

legislation details organisational, record

be treated in the same manner as the US

keeping and business continuity requirements

despite the interconnectedness of EU and

for CCPs, as well as quantum of margin

Swiss economies. In order to ensure that the

and types of eligible collateral CCPs must

only Swiss-based clearing house, SIX x-clear

collect from clearing customers under EMIR

Ltd. obtains Qualifying (QCCP) status under

provisions. The legislation is prescriptive on

CRR and will be able to continue transacting

requirements for eligible collateral, ostensibly

with EU-based counterparties subject to

to ensure that when collateral is needed,

preferential risk weight exposures, the country

it is valuable, unencumbered and liquid.

had to obtain ‘equivalent’ status under EMIR

The legislation disfavours the use of bank

Article 25. A positive equivalence decision is a

guarantees as collateral for these reasons

formal pre-requisite for a third country CCP to

and requires that any such guarantee

apply for recognition with ESMA, which results

offered as collateral is itself fully backed

in QCCP status. For an equivalence decision

by eligible collateral. Yet the legislation

to be issued, the European Commission

includes an unusual three year derogation

needed to determine that the legal and

from these requirements for transactions

supervisory arrangements in Switzerland

in derivatives relating to electricity or

ensure that Swiss-based CCPs are subject

natural gas delivered in the EU, which

to legally binding requirements that are

allowed market participants entering into

equivalent to the requirements of EMIR, that

such derivative contracts to use unfunded

CCPs are subject to effective supervision and

bank guarantees as eligible collateral.

enforcement in Switzerland on an on-going

The derogation was pushed by Swedish,

basis and that the Swiss legal framework

Danish and Finnish regulators prompted by

provides for ‘an effective equivalent system’

Nasdaq and participants in Nordic electricity

for the recognition of freeing CCPs under the

and natural gas market where the use of

country’s legal regime. This process is never

bank guarantees by commercial market

either simple, nor fast and tends to become

participants was prevalent. While it was

highly politicised. A positive equivalence

opposed by other national regulators and has

31

Shaping legislation: UK engagement in EU financial services policy-making

since expired, the derogation demonstrates

Throughout the legislative review process

that concerted efforts by a small number

both the Council and members of the ECON

of national regulators can effect significant

committee struggled with the technicalities

change in how key legislative provisions are

of OTC derivative markets and complex

implemented.

supervision and capital requirements for CCPs. This, as interviewees noted, provided

32

Lessons learnt

an opportunity for the UK. They could use

The UK Government supported the EMIR

the relative expertise of UK Government

legislation and it is easy to see why. The

representatives to recruit support from

legislation offered fair rules for UK market

amongst other member state officials, whose

infrastructure while facilitating the UK

governments considered that what was good

subsidiaries of the large dealer banks that

for market participants established in the

dominate the global OTC derivative markets.

UK would be good for the smaller numbers

This is not to say that the UK Government was

of market participants established in those

wholly successful in achieving all objectives

member states. This strategy has continued

in the legislation but considering some

to serve the UK well both during subsequent

alternative provisions, the outcome was on

legislative negotiations and during the Level

the whole positive.

2 process.

EMIR as a case study offers some important

The EMIR legislation offers some less obvious

lessons for member state governments

lessons too, which are timely and relevant

seeking to shape Union legislation. The more

to this analysis. The events since the formal

obvious lessons include the importance

adoption of the legislation emphasise the

of senior-level engagement in the pre-

difficulties in applying so-called “equivalence

legislative process and the necessity of

provisions� as a means of providing access

close cooperation between member state

to third country market infrastructure, market

government officials in Brussels and national

participants and service providers. As

capitals and those most directly affected by

the fourth anniversary of adoption of the

the proposed legislation, especially where

legislation approaches, it is notable that the

the subject matter is highly-technical.

Commission has yet to formalise the hard-

EMIR demonstrates the utility of informal

fought agreement with US regulators on

coalitions of member state governments

the recognition of US clearing houses, it has

in Council in shaping the general approach.

yet to recognise equivalent US derivatives

Indeed, the informal coalitions established

exchanges and it has not adopted a single

during the EMIR legislative review

decision as regards the equivalence of

re-appeared time and again on other

third country regulatory regimes under Article

legislative dossiers.

13(2) EMIR.

Interviewees generally point to the EMIR

EMIR has caused significant difficulties for

dossier as an example of industry helping

EEA signatories. Nearly four years since the

member state officials work with European

adoption of EMIR and the legislation has

legislators interested in specific aspects of

not been transposed into Annex IX of the

the legislative proposal to build support for

agreement and applied in Norway, Iceland

amendments simultaneously in Council and

or Liechtenstein. At issue, as interviewees

in the ECON committee. While the legislative

note, are the supervisory powers ascribed to

proposal did not seize the attention of most

ESMA in the legislation. Under EMIR, ESMA is

ECON committee members, interviewees

responsible for the authorisation and on-

note that where market participants

going supervision of trade repositories. After

coordinated advocacy with and by

four years of negotiations, a Commission

member state representatives and interested

proposal was published in May 2016 which

legislators, they tended to be successful. The

attempts to solve this issue and allow financial

example of this most frequently cited by

services legislation to be incorporated into

interviewees is the Article 89 EMIR derogation

Annex IX. Under the agreement, ESMA would

for pension schemes.

be able to produce non-binding decisions

covering EEA states, but binding decisions could only be taken by the EFTA surveillance authority. Notably the role of the national authorities in the ESAs is unchanged. Although they will attend as observers they will still not be permitted to vote. Although providing a constitutional mechanism for EEA signatories to apply EMIR without direct supervision

by ESMA, the proposed agreement still provides for a significant role for the ESAs in the supervision of EEA entities. In exercise of its supervisory powers, the EFTA surveillance authority would adopt decisions based on drafts produced by the relevant ESA. In its proposal, the Commission is clear that the intention of this mechanism is to maintain the advantages of having a single European supervisor i.e. to avoid any difference between EU and EEA supervisory practices.

Despite national concerns, in the absence of any other workable solution, the EEA signatories are being asked to accept supervisory decisions drafted by ESMA, in which it plays no formal role. The proposed new system has yet to be implemented and it is not yet clear how it will work in practice.

However, a system predicated on rules and supervision on which the national supervisor has no vote would not be viable for the UK given the significance of the UK financial services industry.

33

Shaping legislation: UK engagement in EU financial services policy-making

Case Study 4

Capital Requirements Directive and Regulation

At a glance

CRD IV

Adopted by EU institutions in 2013 Implements 2009 G20 commitments on strengthening the regulation of the financial sector Applies to EU credit institutions and investment firms Introduces a ‘single rule book’; a single set of harmonised prudential rules for banks and investment firms I ntroduces a bonus cap or a 1:1 ratio between fixed and variable remuneration (2:1 with shareholder consent)

34

Directive 2013/36/EU on access to the

This caused global leaders at a G20 meeting

activity of credit institutions (CRDIV) and the

in April 2009 to state it was necessary to

prudential supervision of credit institutions and

improve the quantity and quality of capital

investment firms and Regulation 575/2013 on

in the banking system, develop a framework

prudential requirements for credit institutions

for stronger liquidity buffers at financial

and investment firms, together make up

institutions, contain the build-up of leverage

the current EU regulatory capital regime for

and implement the recommendations of the

banks and credit institutions. The Directive

Financial Stability Board to mitigate

and Regulation were formally adopted on

pro-cyclicality.

26 June 2013.

In response to this mandate given by the G20, The package has its roots in the Basel

the Group of Central Bank Governors and

Committee on Banking Supervision’s

Heads of Supervision, which is the oversight

“Basel III” accord, negotiations which

body of the Basel Committee on Banking

were triggered by the financial crisis and

Supervision (Basel Committee) agreed on

concluded in December 2010.

a package of measures to strengthen the regulation of the banking sector. These

CRD IV sought to translate the international

measures were endorsed by the Financial

agreement into EU law, and thereby

Stability Board and the G20 leaders at

replaced the directives that comprised the

the September 2009 Pittsburgh Summit. In

initial Capital Requirements Directive: the

December of that year, the Basel Committee

Banking Consolidation Directive (2006/48/

issued detailed rules of new global regulatory

EC) and the Capital Adequacy Directive

standards on bank capital adequacy and

(2006/49/EC). The Capital Requirements

liquidity, now referred to as Basel III. Following

Regulation, or CRR, contains details on the

that and in order to ‘translate’ Basel III into EU

‘single rulebook’, including provisions which embody the majority of the Basel III reforms,

law, the European Commission proposed the CRD IV package in July 2011.

while the Directive contains provisions with a lower degree of prescription.

CRD IV was also used to introduce reforms that were not required by Basel, such as

The transposition deadline for EU member

‘the single rulebook’ for capital definitions

states was 31 December 2013, the

and capital levels, the cap on bankers’

application date of the package 1 January

bonuses, provisions on the reliance on

2014, with the exception of certain provisions

external ratings, corporate governance and

specified in Article 521 of CRR.

administrative sanctions.

The roots of CRD IV

Maximum harmonisation v. national flexibility

CRD IV has its roots firmly in the financial crisis, in which over-leveraged banks and other

For the UK, a lot was at stake throughout the

financial institutions considered ‘too big to fail’

CRD IV negotiations. The UK’s large financial

threatened financial stability and unveiled

system had shown its vulnerability in the wake

a number of shortcomings to the existing

of the financial crisis, with the bail-out of two

international capital regime, Basel II.

of the UK’s largest banks shaking the political

35

Shaping legislation: UK engagement in EU financial services policy-making

establishment and causing a shift away

requirements, as requested by Germany and

from the UK’s principle-based approach to

France. Due to a strong political tide in the

regulation. The fiscal consequences of the

wake of the financial crisis, it did not succeed

two bail-outs had caused domestic regulators

in swaying the UK institutions. This led them

to force domestic banks to deleverage and

to adopt an international strategy by which

strengthen their capital positions. They then

they used international trade bodies to lobby

attempted to engrain this internationally by

more sympathetic member states and others

pushing for narrower definitions of capital,

in Brussels.

higher capital requirements and a binding leverage ratio.

Aside from this government-industry divide, respondents noted that after the UK elections

The UK was fairly successful at this in Basel,

in 2010, there was a divide between the

due in part to the UK’s substantial share of

Bank of England and HMT. The Bank was

chairmanships of sub-committees within

said to be concerned about the prospect

the FSB. Respondents noted the Deputy

of CRD IV forcing the UK to lower existing

Governor of the Bank of England chairing

capital requirements. HMT was at this stage

the Basel Committee on Payment and

no longer steered by a Labour, but by a

Settlement Systems and the FSB Resolution

newly elected Conservative and Lib-Dem

Steering Group and the Chairman of the then

coalition government and said to be more

Financial Services Authority (FSA) chairing the

amenable to concerns that high regulatory

FSB Standing Committee on Supervisory and

capital requirements would make the City less

Regulatory Cooperation, at the time of the

competitive and worsen the UK’s economic

Basel III negotiations.

outlook.

The Basel accord provided a stricter definition

This resulted in pressure on HMT by the

of capital by phasing out the use of so called

Bank, the FSA, as well as members of the UK

‘hybrid’ capital; on capital levels it raised the Core Equity Tier 1 ratio from 2% to 4.5% of

Parliament, which used private channels as well as the media to get their message across.

risk-weighted assets and the accord equally

Eventually, HMT was pushed to make the

introduced a new capital conservation

case for ‘toughening up’ CRD IV, a message

buffer of 2.5%, which would create a total

it could sell better in the Council than one

core equity capital requirement of 7%. The

which broke with its previous Basel stance.

updated standard also stipulated that a new, non-risk based leverage ratio of 3% would

Once this position had been settled, the

be trialled.

UK zoned in on the issue of maximum harmonisation, or the lack of flexibility

The UK was pleased with these changes,

for national regulators to raise capital

which largely matched the tough line

requirements for domestic banks. The draft

national regulators had taken, respondents

legislation provided little leeway for national

said. The Basel III standard was seen as a

regulators to raise capital requirements

sound basis for the EU’s updated prudential

beyond the levels proposed in CRD IV. UK

requirements legislation.

regulators perceived the Commission’s proposal to break with Basel III by legislating

However, the CRD IV proposal drafted by

for both a minimum and maximum level

the Commission was not perceived to be

of capital, thereby prohibiting national

a ‘truthful’ translation of Basel III but a much

regulators from unilaterally imposing higher

weakened version of it, many said. In the UK,

requirements on their banks. In particular, the

the proposal was perceived by legislators to

requirement that the UK would have to seek

threaten the UK’s domestic bank reforms.

EU approval in case capital levels were raised on a temporary basis, as allowed by the draft,

UK banks on the other hand, did not seem

did not sit well with UK legislators.

to share that opinion. They were in favour

36

of an EU single rulebook that would create

Tough negotiations in Council followed, with

a level playing field with regulatory capital

a number of positive and negative outcomes

for the UK, in particular that the position of

demanded further changes. Those in support

the government and the industry was not

of maximum harmonisation included big EU

always aligned.

member states such as France, Germany and Italy, as well as Finland, the European

For example, UK banks made an alliance

Commission and the financial services

with Germany, respondents recalled, to

industry. This meant that in principle, the UK

support the Commission’s proposal to exempt

could be outvoted on the issue in Council.

non-financial counterparties from the Credit

Respondents recalled the strength of the UK’s

Valuation Adjustment (CVA) derivatives

negotiating position, which was described as

charge, despite strong opposition to this by

a ‘moral high-ground’, as well as Germany’s

the UK. Unofficially, the HMT would agree

reluctance to see the UK being trumped on

that the CVA charge was wrongly calibrated,

an issue key to the largest EU financial sector.

but its prevailing objective was to ensure maximum consistency with Basel III. This in turn

The deal reached in Council on 15 May 2012

was motivated by international dynamics,

was largely in line with the UK Government’s

whereby the UK (and other member states)

position, given the circumstances. Although

did not want to give the U.S. an excuse

the Parliament pushed for a bonus cap,

to diverge from the Basel standard in their

which UK legislators opposed (described

national implementation. So while this

below), the agreement on capital

seemed a less than optimal outcome for the

requirements largely held throughout trilogues

UK, it was positive for UK industry.

and made it into the final text.

On capital definitions, which the UK sought

Remuneration

to narrow, it met with significant resistance

Perhaps the most controversial aspects of

from France and Germany, who succeeded

the CRD package – and certainly the most

in diluting proposed capital definitions

highly publicised - were the remuneration

by allowing state support and insurance

requirements. The majority of these had their

subsidiaries to be excluded in the calculation

root in the April 2009 FSB Principles for Sound

of regulatory capital. The concessions

Compensation Practices. These principles

granted to French banks on capital definitions

were drawn up following the financial crisis

were supported by UK industry, as a number

amid widespread concern that the way

of UK banks with large insurance arms stood

banks paid their staff was encouraging

to benefit from the provisions. Again, while

them to take undue risks and to pursue

this was not the desired outcome for the UK

short term investment strategies. The FSB

Government, it represented a significant gain

standards included measures on effective

for UK industry.

governance of compensation, alignment

The UK Government, on the other hand,

and supervisory oversight and stakeholder

of compensation with prudent risk-taking, eventually successfully secured the flexibility

engagement. This included measures such

to vary capital levels without prior approval

as strict limits on guaranteed bonuses and

from the EU. This was notable as the victory

mandatory deferral periods for pay-outs.

was secured in the face of significant

They were intended to apply to large,

opposition. Respondents viewed capital

systemically important investment firms

definitions and the approval issue as two

and credit institutions. As all international

pieces that were traded off against each

standards, they needed to be transposed

other in a fierce battle.

into domestic law.

While the Danish Presidency sought to

Following the adoption of the FSB standards,

partially accommodate the UK (supported

the European Commission launched a public

by Sweden, the Netherlands, Hungary,

consultation on their adoption at the EU

Czech Republic and Bulgaria) by proposing

level in April 2009. The consultation included

a compromise that would allow member

a series of amendments to the existing

states to increase capital buffers up to a

Capital Requirements Directive, which

certain threshold, the UK stood firm and

were eventually adopted in the so-called

37

Shaping legislation: UK engagement in EU financial services policy-making

‘CRD III’ Directive in November 2010. When

(fixed costs). In addition, the UK argued that

the Commission came to propose further

the bonus cap would place European banks

changes to the CRD package in July 2011, so

at international competitive disadvantage

little time had passed since the introduction

as rules on pay would have to be applied

of these new remuneration requirements

globally. The interviewees admit that member

that the Commission proposed minimal

states, including the UK, had been caught

changes only. Key requirements on deferral

off guard by the Parliament’s adoption

of discretionary pay, variable remuneration

of these provisions, with many officials

and the composition of discretionary pay

expecting that they would either fail to pass

remained intact, although the growing

a parliamentary vote or would be discarded

number of firms falling into scope of CRD IV

by centrist and right wing MEPs once in less

meant the rules would apply more broadly.

public negotiations with the Council. This

The Commission proposal therefore did not

view was partially shared also by the HMT,

include any unexpected requirements. The

which at least initially continued to invest

controversial ‘bankers’ bonus cap’, which

most of its political capital on the maximum

evolved into one of the biggest battles

harmonisation issue. Instead, the Council

in recent history of Brussels legislative

met with a Parliamentary team ready to fight

negotiations and ended up with the UK

for the inclusion of the cap right to the final

Government launching a legal challenge in

trilogue. Ultimately MEPs would not back

the Court of Justice of the European Union

down on the inclusion of a bonus cap, and

(CJEU), was added during the negotiations

the Council Presidency was forced to offer a

between the Council and Parliament.

compromise, capping bonuses but allowing

The bonus cap was the reason that in the

Although unpopular amongst some member

eyes of industry, CRD IV became synonymous

states, the deal received the backing of

for a 2:1 ration with shareholder consent.

with overbearing remuneration requirements.

the Economic and Financial (ECOFIN)

Article 94 caps the variable component of

Council, with Ministers keen not to delay the

remuneration at 100% of fixed remuneration,

whole package over a peripheral issue. The

raising to 200% with shareholder approval.

Directive and Regulation were adopted by

A ‘discount factor’ of 25% for ‘bail-in-able’

the Council in June 2013, with the UK being

and deferred instruments was also included

the only country to vote against. Although

to incentivise the payment of bonuses that

the Council technically operates a qualified

encourage a more long-term focus on an

majority voting system, it is very rare for

institution’s performance. These additional

member states not to reach a unanimous

requirements originated in a Parliamentary

compromise. The UK’s vote against

amendment from Belgian Green Party MEP

demonstrates the level of opposition to a

Philippe Lamberts. In the face of continued

provision that would have a disproportionate

high executive pay, even in banks receiving

impact on the City of London, but was also

government financial support, the idea of

seen as overstepping the EU’s competence.

a cap on bonuses gained popular support.

With the vocal backing of non-governmental

The UK Government continued to fight

organisations (NGOs) and many of their

against the bonus cap and looked to the

constituents, MEPs adopted amendments

CJEU to annul the provision. In September

restricting bonuses to 100% of salary and

2013 the government launched a formal

the idea was put forward for discussion

legal challenge, bringing six pleas. The UK

during trilogues.

based its argument on Article 153 (5) of the Treaty of the Functioning of the European

38

The UK strongly opposed the concept of a

Union (TFEU) which covers social policy

bonus cap and fought against the provision

and prevents EU action in relation to pay.

throughout the negotiations. It argued that

It contested the provisions on the basis that

the introduction of the cap would not create

they were disproportionate, failing to comply

disincentives to excessive risk-taking in the

with subsidiarity principle and legal certainty.

banking sector, but it would rather lead to an

The Commission argued that the bonus

increase in base salaries

cap was not a social policy measure but a

prudential financial measure and would not

CCPs) or recognised (third country CCPs).

be subject to restrictions as it did not regulate

Exposures to non-QCCPs are subject to

overall levels of pay. The CJEU did not reach

punitive own fund requirements. However,

a judgement, as the UK withdrew the case

the process of recognition of third country

following a negative opinion from the Court’s

CCPs has been painfully slow, with CCPs

Advocate General, which was delivered on

from the major third country jurisdiction, the

20 November 2013 and which recommended

U.S., still awaiting recognition. CRR included

that all six pleas should be dismissed. While

provisions allowing six-month transitional

non-binding, the opinions of Advocate

period for QCCP exposures. When the

General are in majority followed by the CJEU

original transitional period was close to expiry

in the final ruling. In the face of an almost

in June 2014, the markets were uncertain as

certain loss at the Court, the UK decided to

to whether the extension would be granted.

accept the provisions and began to focus on

The same scenario was repeated four times

national implementation. The Government

afterwards and it is likely to occur again as

has also pledged to continue working at an

the newest deadline of December 2016 will

international level on potential future steps

most likely be missed. De-coupling the link

that could be taken in order to address risks

between CCP recognition under EMIR and

to financial stability stemming from higher

QCCP treatment under CRR has been one

fixed costs at banks.

of the biggest asks of the derivatives market participants raised in the recently concluded

Negotiations on the bonus cap for the

European Commission’s consultation on EMIR

UK should be seen in the context of much

review and broader Call for Evidence on EU

broader discussions. Two main negative

Regulatory Framework for Financial Services.

consequences of the introduction of bonus cap have already been reflected in

Lessons learnt

increased fixed costs of operating in London

The CRD IV context is a particular one, with

in comparison to other financial centres. It

different levels of negotiation: international,

also undermines the claw-back and non-cash

European and domestic. The huge economic

payment of bonuses. The increased salary

shocks of the financial crisis triggered quick

costs also present a problem for international

domestic reforms in the UK, at roughly the

firms operating in London, as they lead to

same time as the revision of international

inconsistencies in their pay policies, which

standards and EU legislation. These revisions

should be applied in a harmonised way

all aimed at a world of more financial stability,

globally. Ultimately, the gains the UK made

but varied in their stringency and flexibility.

on capital requirements would have a much

Whilst CRD IV negotiations resulted in both

greater impact on the market. Although

positive and negative outcomes for the UK

unpopular, it was ultimately the UK’s inability

Government, the UK’s ability to influence at

to secure the backing of other member states

an international (FSB, Basel) level, where it

that allowed the Presidency to propose a

pushed for a relatively strict capital regime,

compromise to the Parliament.

gave it a good negotiating position from the outset of the EU legislative review. Whilst the

Third country implications

UK did not manage to raise regulatory capital

CRD IV/CRR reflects another feature of

levels in the EU and felt the EU translation of

European financial services legislation, i.e.

the Basel accord had not been ‘truthful’, it

interconnectedness between distinct pieces

managed to carve out flexibility for itself that

of legislative act. Such interconnectivity can

allowed it to hold on to domestic rules that

prove to be problematic in international

essentially front-ran the EU regime. Its position

context as demonstrated by an example

as the leading EU financial centre with a

of CRR rules governing banks’ exposures

number of systemically important financial

to CCPs. According to CRR, favourable

institutions assisted in this.

capital charges can only be applied by banks to exposures to QCCPs. For a CCP

Whilst the European Commission is usually a

to be considered QCCP it has to be either

champion of maximum harmonisation and a

authorised in accordance with EMIR (EU

level playing field, the case shows that if an

39

Shaping legislation: UK engagement in EU financial services policy-making

issue is deemed to be of sufficient national

were present throughout trilogues but they

importance, the co-legislators will not shy

were receiving different directions from

away from allowing for flexibility or specific

government. How far this communication

national carve-outs. Equally, allowing for

gap influenced the UK’s influence is difficult

national differences can be an effective

to quantify, but it clearly made the task of

tool in breaking gridlock and securing an

presenting the UK’s case much more difficult.

agreement.

Lastly, whilst the UK itself did not achieve all of its negotiation aims, UK industry fared

CRD IV also serves as a case study in

well through forming international alliances

conducting negotiations in a highly politicised

and targeting other member states than its

environment. While AIFMD had been the

own. The negotiations could be likened to a

first response to the crisis, its application

zero-sum game by which UK perceived losses

was comparatively narrow. CRR got to the

translated into UK industry wins and vice versa.

heart of the causes and the response to

Respondents asserted that whilst ‘official’ UK

the financial crisis. The impact of banking

influence in Brussels on the CRD IV package

regulation is more keenly understood by both

may have been limited, industry influence

national governments and citizens and in

was not.

this context discussion quickly became tense, pitching different perspectives on what the banking sector should look like against each other. This was most clearly seen on the bonus cap. In such a context, the UK’s opposition to the concept of the cap was futile. Had the UK realised earlier that this idea would not simply disappear, they may have been able to better shape the final compromise.

Lessons can also be learnt from the Parliament’s ability to shape the CRD IV legislation. If MEPs approach negotiations with enough determination they can be successful in driving through key reforms. With 73 MEPs, the UK is more likely than a smaller state (e.g. Belgium) to be in a position to raise issues in this way. While the UK’s ability to utilise its MEPs to shape legislation is minimised by the Conservative Party’s position in the European Conservative and Reformists (ECR) Group, the bonus cap originated in an equally small Parliamentary grouping. The way MEPs engage with their colleagues and the issues they chose to champion are also critical to how far national governments and MEPs can influence the legislative process.

Although a fairly obvious lesson, CRD IV provides examples of the need for coordinated messaging and communication.

During trilogue negotiations on CRD IV, the UK ECON Liberal Democrat Committee Chair was in contact with HMT to coordinate the UK position while one of the Conservative shadow rapporteurs was coordinating their position with UKREP instead. Both MEPs

40

Case Study 5

Markets in Financial Infrastructure Directive and Regulation

At a glance

MiFID2/R

Adopted by EU institutions in 2014 Applies to all EU investments firms Regulates previously-unregulated organized trading facilities (OTFs) Introduces safeguards for algorithmic and high frequency trading Strengthens and expands MiFID1 pre and post-trade transparency requirements I ntroduces position limits and reporting for commodity derivatives reates stricter requirements for portfolio C management, investment advice and inducements Completes implementation of 2009 G20 commitments on OTC derivative market reforms

41

Shaping legislation: UK engagement in EU financial services policy-making

Regulation 600/2014 and Directive 2015/65/

of off-exchange trading visible neither

EU on Markets in financial instruments (MiFID

to other market participants or

II and MiFIR) were formally adopted on 15

to regulators. It was the need to drive

May 2014. The legislation is a revision of the

much of this trading onto exchanges and

previous Directive 2004/39/EC on markets

transparent platforms that provided the

in financial instruments (MiFID I) which itself

momentum for the Commission’s work on

replaced Directive 93/22/EEC on investment

the review. A second CESR report built

services in the securities field. The MiFID II/

on this, explicitly recommending that the

MiFIR package provides the basic regulatory

Commission introduce a mandatory post-

structure of European financial markets;

trade transparency regime for corporate

setting out which investment services and

bonds, structured finance products and

activities should be licensed across the

credit derivatives.

EU and the organisational and conduct standards that those providing such services

The Commission assessed that market

should comply with. It includes provisions

and technological developments would

on market structure, pre and post-trade

necessitate a series of reforms to other

transparency requirements, high frequency

aspects of MiFID I. Following additional

trading (HFT) and commodity derivatives

technical advice from CESR, drawn up at

regulation, investor protection measures,

the Commission’s request, the Commission

and a regime for regulating access to EU

launched a public consultation in late

markets by third country firms. MiFIR also

2010. The consultation focused on the

implements the 2009 G20 commitments on

developments in market structures and

the mandatory migration of trading in certain

practices (including the expansion

derivatives to exchanges and regulated

of algorithmic and HFT techniques),

trading venues.

transparency requirements and their scope of application, commodity derivative markets

The roots of MiFID2/R

and investor protection. At this stage, the

Article 65 of MiFID I required the Commission

Commission’s ideas for amendments were

to carry out a series of reviews of certain

fairly well formed, with respondents invited

aspects of the Directive. These reviews took

to comment on specific proposals, albeit not

place during 2007 but following the financial

yet drafted as legislative text. Despite the

crisis there was a growing feeling amongst

Commission having requested the advice,

Commission officials that the key organising

the then-UK Government were concerned

principles of MiFID I, which was focussed on

that so many of CESR’s suggestions had not

‘traditional’ market structure, encompassing

been taken on board. As a member state

shares and regulated markets, needed

with a large and experienced national

updating. What was designed as a technical

regulator, the UK had taken a leading role

exercise in assessing and refining a list of

in drawing up the CESR advice only to see

predefined provisions became a critical

aspects of it disregarded in the final proposals.

exercise in restoring confidence and stability

The reasons for this were largely political.

in EU financial markets.

While the modernisation of the MiFID I

The first steps towards the review came in

transparent trading were the overarching

2009, with the publication of two reports by

objectives of the review, once the package

regime and the need to move towards more

the predecessor to ESMA, the Committee of

was reopened the Commission identified a

European Securities Regulators (CESR). The

series of other provisions it sought to update.

reports highlighted a series of weaknesses

42

in the current regime. The first assessed the

The Commission’s public consultation

impact of MiFID I on the functioning of equity

received over 4200 responses and ultimately

secondary markets, focusing specifically on

led to the publication of legislative proposals

market transparency and the structure of

in October 2011. The UK Government

European trading platforms. Crucially, the

prepared a substantial, 109 page submission

report discusses the emergence of so-called

to the Commission’s consultation, where

‘dark pools’ of liquidity, highlighting the scale

it set out its initial priorities for the MiFID I

review, notably investor protection, third

Facilities (OTFs) falling outside of the existing

country provisions, market structure reform,

regulatory regime and the development of

commodity derivatives and HFT regulation.

HFT were at the centre of the Commission’s

The UK Government’s response highlighted

proposals on market structure. The

the need for any new proposals to meet

Commission’s focus was firmly on the risks

three tests: that proposals were evidence

posed by these developing market sectors,

based, would strengthen the EU Single Market,

although new requirements for OTFs were

and would enhance global competitiveness.

clearly also developed with an eye to

These criteria were repeated by HMT officials

ensuring a level playing field for all platforms.

throughout 2011, however interviewees were

Interviewees noted that member states and

sceptical about the influence of such high

industry participants both saw the necessity of

level rhetoric on the drafting process. By this

updating the MiFID I framework, but as early

stage the review of MiFID was underway and

as 2009 lobbying began fragmenting with

those who were able to assist this process

groups fighting to maintain ‘weaker’ MiFID

by providing technical input were the most

I provisions on their key issues. Interviewees

successful. While the UK was still considering

felt that although the general principles had

how far there was a need to regulate HFT,

broad support, each individual sector of the

those drafting the legislation were already

financial services markets was keen to ensure

forming opinions on how this could be done.

minimal changes to their business model.

Unlike MiFID I, the Commission designed the MiFID II/MiFIR package as a Directive to

The creation of a new regulated OTF was

be implemented by member states and a

intended to create a streamlined regulatory

directly applicable regulation. This approach

regime for the discretionary trading platforms,

was deliberate and was designed to mitigate

largely run by investment firms, that had

the transposition failure of various member

sprung up in the years following the adoption

states under MiFID I. Most notably, provisions

of MiFID I (‘broker crossing networks’).

on executing trades at the most beneficial

Trading on OTFs took place ‘in the dark’ and

terms for clients were implemented in Spain

was counter to the Commission’s aim of

in such a way that brokers continued to

increasing transparency. The creation of

use the country’s main exchange without

the new regulated category was also key

assessing whether better terms or price

to achieving the G20 trading commitments

could be achieved on another European

for derivatives. These required signatories to

platform. With this in mind, and where

ensure that standardised derivative contracts

there was an objective reason for doing so,

were traded on regulated platforms, rather

the Commission tried to include as many

than on a bilateral basis. The large volume

provisions as possible in the regulation. This

of derivative trading taking place on OTFs

included any provisions where there was

meant the Commission could either bring

a direct role for ESMA, including the Article

the trading into a regulated Multilateral

28 MiFIR trading obligation for standardised

Trading Facility (MTF) or exchange, or could

derivatives. It also included provisions where

bring the platforms themselves into the

uniform application across the EU was

regulatory regime in order to meet the G20

essential, most notably the Article 35 and 36

requirements.

MiFIR on non-discriminatory access to CCPs and trading venues and Title II pre and post-

The UK exercised a cautious approach with

trade transparency requirements.

regards to the Commission’s proposals to

Market structure reforms

the move, the UK consequently called for

Although MiFID I had brought about major

clarification of what types of venues would

introduce OTFs. While generally supporting

changes to the structure of EU markets,

be caught by the new category. It also

there were still significant issues of liquidity

argued that the new regime should be based

concentration on certain platforms and

on strong evidence, in particular in the areas

various market practices that led to a

that would require substantial changes to

perceived stifling of competition. The

firms’ business models. The UK advocated in

emergence of new Organised Trading

particular that the OTF regime would allow

43

Shaping legislation: UK engagement in EU financial services policy-making

operators of non-equity OTFs to use their own

the argument, but the interviewees highlight

capital for client trades, in order to facilitate

the positive outcome for the UK-led coalition,

market-making. This position did not find

with the end result being an opening up of

broader support and the final compromise

existing silo structures. This result is considered

includes a general prohibition on dealing

an important achievement for the UK, given

against own capital. The UK was successful,

the amount of political capital expended, in

however, in securing certain important

particular at the late stages of negotiations,

exemptions. Overall, the final compromise

to secure a favourable outcome. As the

includes greater specification of the OTF

majority of technical and operational details

regime, largely in line with the UK’s objectives.

of the newly established open access regime will have to be set out in the implementing

Non-discriminatory access to CCPs and trading venues

measure, the UK has continued its engagement via relevant ESMA committees.

Building on the limited success in breaking down ‘vertical silos’ in derivatives trading

High frequency and algorithmic trading

under EMIR, the Commission included

A key driver of the recast of MiFID I was the

non-discriminatory access provisions in

emergence of new technology and trading

MiFIR. These were intentionally broader in

techniques. Central to addressing emerging

scope that EMIR provisions, covering non-

market risks by modernizing MiFID I were the

discriminatory access to CCPs and trading

new restrictions on HFT. The flash crash of May

venues, and encompassing all types of

2010 was seen as evidence of the need to

financial instruments. As with EMIR the UK

legislate in this area and the Commission’s

found a natural congruence with Commission

plan did not face significant opposition from

officials on this issue. Non-discrimination and

member states. Ahead of the full review of

fair competition were not just policy priorities

MiFID, ESMA began work on applying existing

for the Commission but were seen as core

rules to high frequency and algorithmic

principles of a properly functioning market.

traders. This resulted in the 2011 guidelines on

With so many former DG Internal Market (DG

systems and controls in an automated trading

MARKT) officials having originally worked in

environment (SCATE guidelines), which were

the Commission’s competition department,

intended to provide a framework to national

their outlook naturally lined up with that

competent authorities in applying MiFID I

of the UK. However, positions of member

and MAR to this emerging technology. These

states and European Parliament’s political

guidelines were later evolved to form Article

groups were highly divided. Consequently,

17 and 48 of MiFID II. Again, the European

the ‘open access’ provisions became one

Commission was not making policy in a

of the biggest contentious issues throughout

vacuum, but building on existing practices

the MiFID II/MiFIR negotiations, with the UK

and rules. Although the SCATE guidelines

actively leading the pro-access coalition.

were draw up at a European level, the

Germany led the group of member states

drafting work was carried out by officials from

arguing that forced open access could

national regulators. The UK’s relatively highly

increase risks to market infrastructure and

developed HFT markets meant it played a

opposing mandatory open-access provisions.

central role in this drafting, and by extension

On the industry side, vertically integrated

the drafting of Articles 17 and 48.

market infrastructure providers were natural supporters of more restrictive access

Despite the existence of SCATE guidelines,

provisions, against almost unified buy-and

the legislative review of provisions on

sell-side lobbying in favour of broad non-

algorithmic and HFT saw some very heated

discriminatory arrangements.

debate, in particular in the early stages of the negotiations. The original Commission

44

As a result of lengthy negotiations, the

proposals were considered by the algorithmic

Commission’s initial expansive non-

and HFT community and supportive legislators

discriminatory access provisions were

as extremely onerous. On the other hand,

substantially amended. The necessary

critics of HFT sought to introduce even more

compromise sought to satisfy both sides of

restrictive provisions, such as a 500 millisecond

minimum resting period. These amendments

Michel Barnier, did not need much persuasion

ultimately failed and the final compromise

to include tough provisions in the initial MiFID II

is considered as well-balanced. The UK

drafts. Subsequently, the French government

has generally supported the Commission’s

remained the most vocal supporter of the

objective of introducing robust risk controls for

strict regulation of commodity derivatives

firms involved in algorithmic and HFT trading

throughout the negotiations.

but cautioned against taking an overly restrictive approach in order not to harm the

Parliamentarians were also swayed by

markets; advocating against provisions such

arguments around food speculation

as forcing HFT traders to become market

put forward in extensive NGO lobbying.

makers in all market conditions, introducing

Interviewees recalled email campaigns that

minimum resting times or order-to-transaction

linked MEPs directly to concerned constituents

ratios. The UK and allies were successful in

making it all but impossible for them to speak

unpicking the most damaging provisions

out against the proposed regime. While

proposed by the European Parliament.

generally sympathetic to industry concerns,

The final outcome of the algorithmic and

faced with so many other issues the UK chose

HFT regulation under the MiFID II package

not prioritise negotiations on such a highly

can therefore be considered as successful

politicised issue. Nevertheless the UK did

outcome for the UK, all the more important

advocate for position management over

given its leading role in global financial

the hard position limits. This argument,

marketplace technology development.

however, failed in the course of the negotiations with most MEPs and the

Position limits for commodity derivatives

majority of member states supportive of both

At the 2011 Cannes Summit, the French

mandatory hard position limits applicable to

government had pushed hard for global

all commodity derivative contracts, alongside

action to tackle food price volatility.

position management regime.

This resulted in the Agriculture Ministers’ Declaration on an action plan on price

Member states, including the UK, were

volatility and agriculture. A central pillar of this

insistent that there should be no direct role for

action plan was strengthening regulation of

ESMA in setting and imposing position limits,

financial markets and specifically awarding

resulting in monitoring and management

supervisors formalised position management

powers remaining with national regulators.

powers, including the authority to set ex-ante

Final legislation provides that limits will be

position limits. While the more general MiFID I,

set and imposed by national competent

EMIR and Market Abuse requirements would

authorities (the FCA in the UK), on the basis

serve to make commodity derivatives markets

of methodology developed by ESMA.

more transparent and mitigate the risk of

By maintaining national competence to

manipulative behaviour, management of the

set limits member states, including the UK,

positions of individual firms was intended to

were able to ensure that decisions on the

avoid risk of price volatility associated with

enforcement of limits will be taken in a more

the dominance of a market by one or two

neutral environment and that the limits can

key players. In September 2011, following the

be calibrated to different markets. Member

Washington Summit, the G20 commitments

state and MEPs’ experiences in negotiating

were adopted by the International

commodity position limits provide an

Organisation of Securities Commissions

example of the difficulties faced in managing

(IOSCO) through the Principles for the

discussion on a technical issue, when the

Regulation and Supervision of Commodity

high level messaging has become

Derivatives Markets. These principles formed

so emotionally charged. This debate

the basis of the Article 57 and 58 requirements,

continues, albeit to a lesser extent, during

introducing respectively position limits and

the ongoing implementation phase with

position reporting for commodity derivatives.

the development of regulatory technical

Perhaps more notably, the G20 process also

standards on commodity derivatives

crystalized French support for the initiative. The

regulation being one of the most challenging

French Commissioner for the internal market,

elements of the process.

45

Shaping legislation: UK engagement in EU financial services policy-making

Investor protection

regime, it is worth noting that the UK is as

In 2006 the UK FSA began work on the

free to make use of this discretion as any

Retail Distribution Review (RDR). The RDR was

other member state, which means that it can

a complete overhaul of the UK’s rules on

apply its more rigorous regime via national

providing advice to clients, with the headline

legislation.

reform of banning advisers receiving commission from funds in return for sales.

Third country regime

The final RDR rules were published in

As with every piece of recent EU financial

Summer 2012, but were the result of years

services legislation, the MiFID II package

of consultation and research. When drafting

includes a separate set of provisions

the investor protection requirements in

governing the access of third country firms

MiFID II the Commission took on many of

to the Union markets. MiFID I did not include

the ideas the UK had included in the RDR.

a harmonised third country regime, leaving

Through early adoption of rules that went

regulation of access to national markets to

further than existing MiFID I requirements

the discretion of member states. Ensuring

the UK was able to shape the Commission’s

workable third country provisions was one

revision to the framework. In this way, the FSA

of the UK’s main objectives both during

influenced the Commission to a far greater

MiFID II preparatory phase and subsequently

extent than member states with no national

during legislative negotiations. Recognising

provisions, despite lobbying from national

the importance of global financial markets

governments. However, the flipside of the

and their mutual interconnectivity, the UK

early adoption of the RDR was that the UK

has been strongly of the opinion that one

had very little or no room for manoeuvre

of the cornerstones for Europe’s continuous

during the subsequent legislative negotiations.

growth should be undisrupted access to

The initial Commission proposal was

firms. This would not be possible should the

extensively amended by MEPs, most notably

legislators have chosen to impose overly

the German rapporteur, Markus Ferber.

restrictive provisions on foreign firms seeking

international financial markets for European

Provisions on ensuring ‘best execution’ for

access to European markets. The UK therefore

clients were amended to such an extent

opposed the approach adopted in the

that an unreasonable burden would be

original Commission proposal, which based

placed on firms to ‘take all necessary’ steps

MiFID II third country provisions on the strict

to ensure best price was achieved. The

equivalence principle, not dissimilar to the

wording was eventually softened during

infamous EMIR regime.

trilogue negotiations, but in compromising some of the precision was lost. Although

46

Third country provisions were amongst the

the UK was undoubtedly successful in

most controversial issues in the review, with

shaping the investor protection regime, one

strong divisions between the Council and

interviewee did suggest that the extent of

European Parliament. The Council favoured a

member state discretion in implementing

more flexible approach and argued against

the regime means it falls short of the blanket

the deletion of the equivalence requirements

ban on inducements the UK would have

in their entirety. Member states, including

liked. This was seen as surprising, given the

the UK, were keen to maintain control over

UK was viewed by many as being on ‘the

access to their respective markets but also

right side of the argument.’ This discretion for

were concerned with potentially detrimental

national authorities has been maintained in

effects of tightening the regime on European

the drafting of implementing measures by

economy. Eventually the middle ground was

the Commission, who have taken the unusual

found, which allows third country firms to

step of drafting a Delegated Directive,

continue providing investment services in a

rather than a regulation to implement the

single member state subject to national-level

provisions. This will again provide scope for

approval. In order to obtain a ‘passport’, i.e.

member states to also interpret the detailed

to use authorisation in one member state

technical rules at a national level. Although

only in order to provide investment services

this hampers the creation of a harmonised

in all EU member states, the Commission

would have to grant a positive equivalence

concerns with the EU this had not led to any

assessment to a third country jurisdiction

concessions. In order to maintain access

where a firm is located. Transitional

to the key export market for Swiss financial

provisions have been put in place to ensure

services, Switzerland set about drafting

undisrupted functioning of the markets. The

‘equivalent’ national law. While not identical

compromise on third country provisions is by

this will have to mirror all the key MiFID II

far one of the most positive UK outcomes in

provisions.

the MiFID II package.

The UK has also proven that it is able to

Lessons learnt

successfully work towards a workable

The UK had a stake in almost all the key

compromise with Union legislators and the

provisions during the MiFID II negotiations.

Commission. With the growing role of the

This made reaching trade-offs with other

European Parliament in the decision-making

member states difficult and also cast the UK

process, it is also essential to be able to

as an awkward partner in the negotiations,

exercise influence at this level. The UK were

repeatedly having to take issue with

lucky to have two influential British MEPs

proposed compromises and Commission

active on the file, enabling coordination

drafting. Although the MiFID review was

and mutual support on key provisions.

well telegraphed and did not take any

The Parliament’s position is usually more

member states by surprise, with 10,000 market

politicised than that of the Council, often

participants under its supervision, the UK had

leading to difficult negotiations and where

a harder task than most in coordinating its

the chances of successful engagement are

response. Despite this, the UK was much more

only possible for insiders.

open and more aggressive in coordinating with other member states on issues where there were mutual concerns. This willingness to compromise has continued through the implementation on MiFID II. In March 2015, the UK, German and French governments co-signed a letter to ESMA detailing concerns with the draft implementing measures. This level of cooperation was not seen during earlier negotiations and is symptomatic of growing confidence at HMT in engaging in the political process as well as technical discussions.

When finalising the regime for granting access to EU markets for third countries firms, there is an argument that the lessons of EMIR were not yet fully apparent, as the extent of difficulties in the discussion on CCP equivalence with the US only materialised in late 2013. As such, the MiFID II third country regime has many of the same pitfalls as EMIR. The process for granting equivalence for non-EU firms will continue to be restrictive.

While a lack of EMIR equivalence has a direct impact on access to EU markets for CCPs, the implications under MiFID II are much broader. Despite this, the EEA states were not consulted on the EU’s approach to equivalence. Interviewees pointed out that although Switzerland had raised

47

Shaping legislation: UK engagement in EU financial services policy-making

3.

Conclusions

The five case studies demonstrate the breadth of opportunities that EU member states have to shape EU legislation, from the initial proposal through to implementation. The UK has been able to play a significant role in shaping major pieces of financial services legislation, acting both independently and in coalition with like-minded member states.

EEA and EFTA memberships are often held up as alternative models of engagement for the UK in the event of Brexit. The case studies show that these models effectively require countries to implement EU or equivalent legislation, without having had the opportunity to shape it.

This section brings together the lessons learned from the UK’s and other countries’ engagement around the five pieces of legislation reviewed, to identify the characteristics that lead to successful influencing.

48

Opportunities to engage in EU legislation

The case studies highlight the wide range

The UK has the largest and most diverse

of opportunities that member states have

financial services sector of any member state.

to engage around policy making, from

Consequently, the UK Government represents

proposal to implementation.

a larger and more diverse set of sectoral

The European Commission’s decision making

government on any given legislative proposal

is part of a detailed, continuous dialogue

in financial services.

interests than any other member state

with national governments, member states’ representatives, and wider multilateral forums

In addition, EU legislation is embedded in a

and organisations, such as the G20 and FSB.

wider global context. The UK Government

This analysis suggests that the UK Government

bodies such as the Basel Committee, the

is well-represented in global regulatory is not isolated within the Council and is able

Financial Stability Board, the International

to work with others to effectively influence

Association of Insurance Supervisors (IAIS)

draft legislation. The UK Government has

and IOSCO. UK Government institutions hold

solicited the support of others via informal

a number of leadership positions in these

coalitions of free market orientated member

bodies and are active within them. As

state governments, including Netherlands,

evidenced in the cases of EMIR and CRD

Denmark, Finland and the Czech Republic.

IV, the UK Government has been able to

Together they have helped shape proposals,

shape the commitments and standards that

including around EMIR and MiFID II.

the Commission later uses as the basis for financial services legislation.

49

Shaping legislation: UK engagement in EU financial services policy-making

UK’s role in shaping EU legislation

The case studies demonstrate that the UK

p The Capital Requirements Directive and

Government has been largely successful

Regulation (CRD IV/CRR): Allowed the UK

in shaping legislation, as evidenced in the

to set high capital reserve requirement

Solvency II, EMIR, MiFID II and CRD IV case

for financial institutions in Europe while

studies. Even on legislation which it has

maintaining national discretion in applying

generally opposed, such as AIFMD, the UK

the rules. .

Government was successful in delivering amendments to key provisions and, from

p Markets in Financial Infrastructure Directive and Regulation (MiFID II/MiFIR): The UK

its perspective, materially improving the

preserved the passporting regime set out in

legislation ultimately adopted.

MiFID, which was key for UK-based financial

Key successful outcomes for the UK

customers.

firms’ ability to access 500 million European highlighted in the analysis are:

p The process of developing legislation is consensus-based, and as such, the UK

p Solvency II Directive: The UK shaped EU

entirely the outcomes it would wish.

the level of European insurance capital

Most notably, in the case of AIFMD, the

requirements.

UK Government never truly supported

p Alternative Investment Fund managers

its objectives or core provisions. The UK

Directive (AIFMD): The UK safeguarded

Government also accepted significant

London’s status as a global investment

reverses on key elements of legislation,

hub by preserving the National Private

such as the group support provisions in

Placement Regime. p The European Market Infrastructure

Solvency II and the access to clearing provisions in EMIR. In some cases, the UK

Regulation (EMIR): UK Government efforts

Government has gone further, most notably

ensured that clearing houses such as ICE

in challenging the legality of the CRD IV

Clear and LCH.Clearnet could continue to operate without restrictive rules that would discriminate against them for being outside of the Eurozone.

50

Government has not always achieved

legislation to match the UK’s and raise

’bonus cap’ at the European Court of Justice.

Third country influence – EFTA and EEA members and financial services legislation The case studies indicate significant legal

On 31 May 2016 the Commission finally put

challenges in incorporating post-crisis Union

forward draft legislation to attempt to resolve

financial services legislation into the existing

this issue. However, at the time of writing, this

EEA Agreement. For example, the Solvency

legislation is yet to receive formal approval

II Directive is included in Annex IX of the EEA

from the national parliaments of Iceland

Agreement so that it can apply to insurers

and Norway or the Council. Additionally

and reinsurers in Norway, Iceland and

this will only apply to the implementation

Liechtenstein. This allows them to provide

process. The supervisory authorities of the

services across the Single Market. However,

EEA will remain observers at ESA meetings

despite being EEA relevant, none of the

and will have no vote. In areas of legislation

other pieces of legislation covered in these

that require direct supervision, entities in EU

case studies have been included in the EEA

signatory states will be supervised by the EFTA

Annex to date. Even for directives that have

surveillance authority, rather than the ESAs,

been included in Annex IX, closer inspection

but this supervision will be based on decisions

shows that, with the exception of Regulation

drafted by the ESAs. This will leave the EEA

1060/2009, primary regulation has not been

signatories effectively being handed down

included in the Annex to date. This in turn

the decisions by ESAs, without the right to

undermines the preferential access to the

vote during the decision-making process. EEA

Single Market established for EEA states.

signatories will continue to have no influence over the legislative review process, when the

This is caused by the emergence of the

legislation is being shaped and politically

European System of Financial Supervision

sensitive decisions are taken. Additionally,

in 2010. It enabled the three ESAs, the

they will be asked to contribute financially,

EBA, EIOPA and ESMA to bind member

to the same level as the EU members, to the

state regulators in certain circumstances.

running of the ESAs.

Although the supervisory authorities of the EEA countries have observer status at the EBA, EIOPA and ESMA, the ESFS currently has no place for EEA national supervisory authorities.

The EEA Agreement also does not have provisions to accommodate the ESFS or the powers of the ESAs.

51

Shaping legislation: UK engagement in EU financial services policy-making

Switzerland and equivalence mechanisms

Switzerland is not an EEA signatory. It

In addition, Bilateral agreements are

has remained an EFTA member. Formal

mutually dependent. This means that a

EU-Switzerland relations with the EU

breach of one agreement may invalidate

are governed by a series of sectorial

all other related bilateral agreements. The

agreements, the so-called “Bilaterals�. The

future of the Bilaterals arrangement has

Bilaterals are based on the EEC-Switzerland

been called into question with the 2014 vote

free-trade agreement of 1972 and were

by the Swiss electorate backing an initiative

signed in 1999 and expanded in 2004. There

to introduce migration quotas, covering EU

are over 100 bilateral agreements that

persons. Any such quota would be a breach

regulate trade relations between the EU and

of the 1999 EU-Switzerland Agreement on

Switzerland.

the Free Movement of Persons, and hence could invalidate all other agreements. As

The Bilaterals do not extend to financial

yet, the Swiss Federal Government has not

services, with the sole exception of non-life

implemented the migration quotas.

insurance. Regardless of EFTA membership,

Whatever the future of the Bilateral

Switzerland has no preferential access

agreements, the prospects for expanding

to the Single Market for financial services

any agreement to provide preferential

(with the exception of non-life insurance).

access for Swiss financial institutions and

For Switzerland to gain access, as with

market infrastructure are remote.

other third countries, they must seek an equivalence decision from the EU, where their legislation and implementation of legislation is deemed equivalent to that of the EU. There is no formal consultation process between the EU institutions and the Swiss Federal Government on draft financial services legislation. The Swiss Federal Government is free to lobby the EU institutions on such legislation, however the case studies suggest that it has had little discernible influence.

52

Lessons learned for successful engagement

The case studies have highlighted the ways

and an understanding of the aspects that

in which the UK and other member state

other member states will view as unacceptable,

governments have succeeded in shaping

especially if these relate to different perspectives

legislation. There are a number of lessons to

on the objectives, as with CRD IV. The German

be drawn out from the ways in which this has

approach to Solvency II illustrated the benefits of

been achieved – and ways in which the UK

focused early engagement, in contrast with the

could better engage to influence legislation.

UK’s initial stance on AIFMD.

The process of developing EU legislation

The degree of change possible across the

through to implementation can be long – in

process of legislative review and implementation

the case of Solvency II, the process took

also illustrates the importance of considering

over ten years. This requires a substantial

all forums and approaches for negotiation.

commitment to engagement over time, and

The experiences of AIFMD show the potential

the ability to plan to these time-frames and

importance of the Level 2 technical stage, and

set long term goals. Given the important role

subsequently the role that review clauses and

that individuals can play in these negotiations,

temporary derogations can have in mitigating

a degree of consistency in both national

potentially deleterious legislation and enabling

objectives and lead personnel is critical.

subsequent further negotiation.

The case studies demonstrate the important

Finally, in order to engage effectively, it is

role that the financial services industry can

important to have key individuals in positions

play. Industry experts can help to shape the

in which they can have a voice, and

technical details of the legislation, as well

spearheading a co-ordinated response. The

as providing data and evidence to help

UK should look to increase the number of British

legislators understand the likely impact of

staff at the European Commission and assess

legislation both singly and cumulatively,

whether staff at the Permanent Representation

as with AIFMD and EMIR. CRD IV also

to the EU are of an appropriate level of seniority

demonstrated the power of international

and are in their positions long enough to

alliances formed by industry. While the

establish relationships with Commission policy

extensive nature of the UK’s financial services

makers, other Member State representatives and

industry can on occasion make co-ordinating

European legislators.

a national response complicated - as with MiFID 2 - the breadth and depth of expertise

In addition, the UK is well-represented in

that this offers is a huge benefit. The lessons

the Parliament – with 73 MEPs, behind only

drawn from Solvency II suggest that the role

Germany (96), and France (74). Their political

of data and evidence in informing legislative

groupings, such as the Conservative’s position

processes will continue to increase in

in the European Conservatives and Reformists

importance.

(ECR) Group, can however make for less effective engagement, unless due care is given

Political engagement and sensitivity –

to engagement with wider MEP colleagues.

alongside technical input – is clearly key

Likewise key is careful choice of the issues to

throughout the negotiation process. Forming

champion, and ensuring coordination across

coalitions with member states with similar

key players, as highlighted by CRD IV. There

interests, and being willing to compromise

is also an important role for national officials

on lower priority issues to ensure key aims

in key positions, such as the UK Rapporteur for

are achieved, has been critical, for example

the European Parliament during Solvency II –

with Solvency II, and EMIR. Alongside this, it

emphasising the importance of UK staff playing

is necessary to have clear national priorities

an active role within the Parliament.

53

Shaping legislation: UK engagement in EU financial services policy-making

Summary

The analysis shows that the UK is only able to effectively shape EU financial legislation through its membership of the Union. The report overall demonstrates that the UK Government is effective in exerting influence on EU financial services policy.

No alternative arrangements, such as EEA or EFTA membership, provide the same level of potential influence. Were the UK to leave the Union, EU and UK markets would continue to be closely linked. These close ties would ultimately require the UK to adopt national legislation in line with that of the EU in order to ensure its continued access to the Single Market. Adopting these arrangements for the UK would inevitably mean that the UK would need to implement EU legislation without being able to shape it.

54

Annex Annex I: Glossary

Acronym

Definition

AIFMD

Alternative Investment Fund Managers Directive

BCBS

Basel Committee on Banking Supervision

CCP

Central Counterparty under EMIR

CDR

Commission Delegated Regulation

CEIOPS

Committee of European Insurance and Occupational Pensions Supervisors

CESR

Committee of European Securities Regulators

CJEU

Court of Justice of the European Union

Council

Council of the European Union

CRD IV/CRR

Capital Requirements Directive IV and Regulation

CVA

Credit Valuation Adjustment

DG FISMA

European Commission Directorate General for Financial Stability,

DG MARKT

European Commission Directorate General for the Internal Market

Financial Services and Capital Markets Union and Services EBA

European Banking Authority

ECB

European Central Bank

ECOFIN

Economic and Financial Affairs Council

ECON Committee

European Parliament Economic and Monetary Affairs Committee

ECR

European Conservatives and Reformists

ECSC

European Coal and Steel Community

EEA

European Economic Area

EFTA

European Free Trade Association

EIOPA

European Insurance and Occupational Pensions Authority

EMIR

European Market Infrastructure Regulation

EPP

European People’s Party

ESA

European Supervisory Authority

ESFS

European System of Financial Supervision

ESMA

European Securities and Markets Authority

EU

European Union

FCA

Financial Conduct Authority (UK)

FSA

Financial Services Authority (UK predecessor to FCA and PRA)

FSB

Financial Stability Board

HFT

High-Frequency Trading

HMT

Her Majesty’s Treasury (UK)

IAIS

International Association of Insurance Supervisors

IOSCO

International Organisation of Securities Commissions

ISDA

International Swaps and Derivatives Association

MEP

Member of the European Parliament

MiFID II/MiFIR

Markets in Financial Infrastructure Directive II and Regulation

MTF

Multilateral Trading Facility under MiFID II

55

Shaping legislation: UK engagement in EU financial services policy-making

NGO

Non-governmental Organisation

NPPR

National Private Placement Regimes

OTC

Over the Counter

OTF

Organised Trading Facilities under MiFID II

PRA

Prudential Regulation Authority (UK)

QCCP

Qualifying Central Counterparty under EMIR

QIS5

Quantitative impact study 5 (Solvency II)

RDR

FCA Retail Distribution Review

SCATE guidelines

ESMA guidelines on systems and controls in an automated trading environment

56

TEU

Treaty on European Union

TFEU

Treaty on the Functioning of the European Union

TR

Trade Repository

UCITS

Undertakings for Collective Investment in Transferable Securities

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59

Shaping legislation: UK engagement in EU financial services policy-making

Annex III: Interviewees The following participants in the study have given their permission to be cited in this report.

60

Name

Role

Andrew Baker

Former CEO, AIMA

Edward Bowles

Head of Corporate and Public Affairs, Standard Chartered

Sharon Bowles

Member of the House of Lords, Former Chair of the ECON Committee

Michael Collins

Former Financial Counsellor, UKREP

Rory Cunningham

Head of Compliance (Asia) LCH Clearnet

Richard Gardiner

Head of Public and Regulatory Affairs, FESE

Dominique Graber

Head of European Public Affairs, BNP Paribas

Knut Hermansen

Minister Counsellor, Norwegian Mission to the EU

Matthias Heer

Financial Counsellor, Mission of Switzerland to the EU

Karel van Hulle

Former Head of Insurance and Pensions, European Commission

Antony Manchester

Senior Adviser, Swiss Finance Council, Former Financial Counsellor, UKREP

Rafael Plata

Former Head of Market Infrastructure Policy, FESE

Robert Priester

Deputy Chief Executive, European Banking Federation

Simon Puleston Jones

CEO, FIA Europe

Hugh Savill

Director of Regulation, ABI

Niels Tomm

Head of Governmental Affairs & Political Communication, DBAG

Shaping legislation: UK engagement in EU financial services policy-making RESEARCH REPORT PUBLISHED BY THE CITY OF LONDON CORPORATION JUNE 2016