The disappointing EU record on financial services

Could financial services take centre stage in the British referendum on EU membership? One of the UK’s strongest sectors now seems to be questioning what EU membership has delivered. A tide of legislation since the financial crisis has hit UK asset managers and banks hard. Asset managers, in particular, are not sure why. A working EU capital markets union still seems years away. Without fundamental reform in the legislative process, the City could swing to supporting Brexit.

The UK economy emphasises services, an area where EU benefits to exporters are less visible. And, for the part of the financial services sector that operates entirely domestically, EU legislation seems more about pain than gain. Investment firms find they must constantly adapt to new rules, often with insufficient timescales for consultation and implementation. Not all of this seems geared towards either protecting the consumer or improving competition.

An EU action plan on building a capital markets union by 2019 looks too late, and unconvincing. It offers a commendable wish list and talks vaguely of removing barriers. But, a recent European consultation side-stepped the big issues, such as whether EU regulation is actually capable of making use of modern technology? Submitting information on paper to each member state still seems the norm, without standardisation on format. And, where technology has been accepted, little thought seems to be given to practicality. Best execution reporting, for example, involves the collation of billions of data fields.

The European Commission has just completed collecting evidence on the EU regulatory framework for financial services. That aimed to identify unnecessary regulatory burdens and bad legislation. But, given its desire to investigate detailed evidence, improvements may take time. Prescriptive EU regulation may not sit easily with a UK principles-based regulatory approach.

The biggest challenge for the UK appears to be the proposal for a financial transaction tax (FTT). This is expected to push up costs for all users of financial markets and reduce liquidity. Few expect the tax to raise much revenue. Instead, the proposed implementation of this new tax in only a few member states seems likely to introduce distortions in the operation of capital markets across the EU. And it runs directly counter to capital markets union objectives to maximise growth and job creation. FTT looks like a gift to campaigners for Britich exit in the Referendum debate.

Some legislation is creating unforeseen consequences. Many more asset managers will soon be caught by legislation on remuneration, through the interaction of conflicting rules. This seems to work against individual risk mitigation in smaller firms. One set of legislation recognised proportionality, only for new rules to cast a wider net and remove hard-won exemptions.

Other EU legislation has hit UCITS managers. It is still hard to market UCITS across borders. One major problem is that individual states can set their own rules for the paying agent requirement. This third-party structure creates extra costs, and appears not to recognise technological developments since the original UCITS directive 30 years’ ago. It is particularly challenging for alternative investment funds such as hedge funds and investment trusts.

Reporting requirements, too, can be onerous. These are a combination of EU-level obligations and national ones. Gold-plating – additional national requirements – of performance and cost disclosures, prevent firms from developing EU-harmonised marketing materials. Some member states still insist that asset management companies file marketing documents in hard copy with national regulators, rather than permitting electronic filing. For firms with dozens of UCITS, often with many separate share classes, submitting these across 28 countries is a nightmare.

It should be possible for the EU to keep up better with the pace of change in technology and in developments in other financial markets. For example, the US makes better use of the ability to rescind outmoded rules via no-action letters. The EU could, for example, mandate the use by regulators of a standard on data such as ISO 20022, which allows fully electronic filings on a standardised basis. It is hard to see how the EU can encourage new online and mobile business models for financial services, when the existing regime involves so much paperwork.

Simply dealing in shares can be a minefield for institutional investors. Confusion is created by the threshold for the notification of major holdings set at 5%. Individual states can, and do, set different levels, such as 3%. Time periods for notifications and penalties also vary widely. Obligations and fines can arise even where voting rights have changed simply because a company has reduced its issued share capital, forcing a passive and minimal crossing of a notification threshold.

Will the next few months see the European Securities and Markets Authority (ESMA) recognise its contribution to the Brexit debate? The MiFID II delay – with apparent friction between ESMA and the European Parliament committee, ECON – is not a good advert for the EU regulatory process. Financial services may be intangible, and therefore not the stuff of headlines, but it is a big sector for the UK.

Part of the problem may be the way the European Commission develops legislation. More time should be made for consultation, and there is a need for practical implementation deadlines. The various Commission services could be more closely co-ordinated. And, although the Commission talks about “better regulation” it needs to look more carefully at the impact of new legislation. The Commission’s preference for lifting old definitions into new legislation can have unintended consequences. It could even take action against states that are creating additional or even illegal burdens on participants. The time and cost of recovery of the withholding taxes can be a real deterrent to cross border investment by funds.

The challenge to European regulators is co-ordination, practicality, proportionality and use of technology. Getting this right could help to keep Britain in the EU. But, the bigger prize for Europe could be finally improving the flow of savings to boost economic growth.

A version of this article was published as an Op-Ed in Financial News on February 15 2016.

Disclosure: The opinions expressed in this article are my own, and may not represent the views of any firm or entity with which I am affiliated. I have no business relationship with any company mentioned in this article. The information presented in this article has been obtained from sources believed to be reliable; however, I make no representation as to their accuracy or completeness and accept no liability for loss arising from the use of the material. Articles and information do not represent investment advice.

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