Following the recommendations of the de Larosière report, in September 2009 the European Commission adopted a package of five legislative proposals aimed to reform the European framework for supervision of the financial system, based on two new pillars: a European Systemic Risk Board (ESRB) and a European System of Financial Supervisors (ESFS). The Commission proposed three separate regulations to establish a European Banking Authority (EBA), a European Insurance and Occupational Pensions Authority (EIOPA) entered into force in December 2010, and then the three EU authorities were established in January 2011. A EU supervision of the financial system has been in place since then, and powers have been transferred from the UK’s Financial Services Authority to the new European Supervisory Authorities.
It is important to recall that there is no legal basis in the Treaty, which allows the creation of these new EU-level authorities with binding powers. The Commission has justified its choice of Article 114 TFEU (Article 95 of the EC Treaty) as legal basis stressing that the creation of the ESRB and of the ESFS will improve the functioning of the Internal Market. At the time, the European Scrutiny Committee as well as the Treasury Committee has raised concerns over the legality of the proposals as regards the delegation of powers. Under the principle of conferral the Community can only act within the limits of the competences conferred on it by the member states to attain the objectives set out in the Treaties. The ECJ has decided on the limits to the delegation of powers to agencies in the 1958 Meroni judgment (Meroni & Co., Industrie Metallurgiche, SpA v High Authority of the European Coal and Steel Community). The Court set up a general principle “A delegating authority cannot confer upon the authority receiving the delegation powers different from those which it has itself received under the Treaty.” The Court also stated that the delegating authority “must take an express decision transferring” the powers. Moreover, according to the Court the discretionary delegation of powers to bodies, which are not foreseen in the treaty, would imply a wide margin of appreciation, replacing “the choices of the delegator by the choices of the delegate”, entailing, in this way, “an actual transfer of responsibility.” The Court has stressed that the discretionary delegation of powers to such bodies would infringe the ‘principle of institutional balance.’
One could argue that the above-mentioned regulations are not consistent with the Meroni doctrine nonetheless the proposals went through, and Member states’ control over the supervision of their financial institutions have been substantially reduced. There has been a transfer of powers from national financial supervisors to the EU authorities, which have binding powers to supervise cross-border firms in banking, securities and insurance sectors. The Financial Services Authority would see its powers progressively reduced. The ESAs coordinate supervision of cross-border financial groups, solve disputes between national supervisors, monitor the application of Community law, supervise credit rating agencies and make decisions during crises. Moreover, they contribute to the establishment of common regulatory and supervisory standards. They have enforcement powers, powers to adopt emergency decisions and powers to settle disagreements between competent authorities. Hence one could say that the EU regulations went further beyond what is necessary to achieve the objective pursued – “improving the functioning of the internal market.”
The measures proposed under Article 114 TFEU have to be adopted by the Council and the European Parliament (ordinary legislative procedure) with QMV required at the Council. It was impossible, therefore, to veto the proposals. The then labour government was particularly against ESAs having the power to adopt specific emergency decisions, in crisis situations and conferring to the new ESAs powers of binding mediation over national supervisors. But Gordon Brown and Alistair Darling were unable to defend the UK interests. This EU framework proposed by the unelected European Commission, then agreed by the Council by majority vote and by the European Parliament through the ordinary legislative and then adjudicated by the European Court of Justice has been imposed upon the UK against the national interest. At the time, Bill Cash condemned Gordon Brown for “creating circumstances which would lead to the betrayal of the United Kingdom and the City of London”. As Bill Cash said “the European financial regulatory structure, covering the whole of the financial regulations, establishing three new European supervisory authorities – a European Banking Authority (EBA), a European Insurance and Occupational Pensions Authority (EIOPA) and a European Securities and Markets Authority (ESMA) (…) is not just a matter of mere “supervision” but of the creation of overall judicial architecture, conferring European Court of Justice jurisdiction over the City and over large swathes of financial services and economic affairs, which represent a very substantial proportion of our economy.” In December 2009, Bill Cash said in the House of Commons “Those who are promoting this whole superstructure, including the Government and Lord Myners himself, would hand over the City of London, lock, stock and barrel to a supervisory authority that will insist that it has its way. That is the problem and it is completely contrary to proper market conditions.” He stressed “The United Kingdom will no longer be able to insist upon retaining its own control over financial services and banking in the City of London and across the country” and “The Westminster Parliament will be obliged to accept the legislation which includes the overarching legal architecture and final jurisdiction of the European Court of Justice.” Bill Cash has now been proved right.
In 2010, at Germany and France request, the European Commission put forward a proposal for a regulation on short selling and certain aspects of Credit Default Swaps (CDS). This Regulation was adopted and entered into force in 2012. The EU regulation on short selling and certain aspects of Credit Default Swaps (CDS) has harmonised requirements relating to short selling in the EU as well as powers that regulators may use in exceptional situations, in case of serious threat to financial stability or market confidence. Moreover, it entails further transfer of powers from national regulators to the European Securities and Markets Authority (ESMA). The European Commission has based the proposal on Article 114 TFEU.
The Government could not support the Commission’s proposals on disclosure requirements and restrictions on naked short selling relating to sovereign debt as they are likely to have an adverse impact on sovereign bond markets as well as on a sovereign’s cost of borrowing. The Government said, during the negotiations, that the Commission’s proposal “implies significant and unmet ongoing costs for both firms and individuals, trading venues and clearing houses in establishing the infrastructure necessary to meet its requirements.” The Government has therefore opposed to the proposal, as it would increase the costs for governments seeking to raise money to finance their debt. However, the proposal was subject to the ordinary legislative procedure with QMV required at the Council, and the UK could not water it down. Unfortunately, this is another example of the UK being outvoted on EU financial regulations.
Despite UK’s opposition, the Regulation agreed by the European Parliament and the Council addresses both short selling and CDS. A permanent ban on naked short selling of bonds and shares, and on so-called naked credit default swaps has been imposed within the EU. The prohibition of naked CDS on sovereign debt was a victory for the European Parliament but a blow to the UK.
Under the Regulation, in order to deal with concerns that CDS curbs could negatively affect the liquidity of sovereign debt markets, a competent authority (national regulators) may temporarily suspend the restrictions, and lift the ban, if they believe that it is harming their sovereign debt market. However, this possibility is very limited. National regulators are required to show their sovereign debt market is not functioning properly and that such restrictions could have “a negative impact on the sovereign credit default swap market, especially by increasing the cost of borrowing for sovereign issuers or affecting the sovereign issuer’s ability to issue new debt.”
Member states’ competent authorities may impose a temporary restriction on short selling of a financial instrument, in case of a significant fall in the price of the instrument on a trading venue in a single day, until the end of the next trading day or up to a further two trading days. However, before imposing such measures, they are required to notify ESMA. ESMA will then inform the competent authorities of the other member states whose trading venues trade the same instrument, so that they can apply the same measures. If national regulators disagreed over this matter and cannot reach an agreement, ESMA has legally biding mediation powers to settle such dispute. Hence, ESMA may take a decision requiring national regulators to take specific action or to refrain from action, “with binding effects for the competent authorities concerned, in order to ensure compliance with Union law.” It would, therefore, override, in this way, national regulators’ decisions. ESMA will “perform a facilitation and coordination role in relation to measures taken by competent authorities” in exceptional situations. Moreover, member states’ competent authorities must notify ESMA of the measures they intend to introduce within one day. Then, ESMA, within 24 hours, will issue an opinion stating whether the proposed measure is suitable to address the threat and whether the duration of the measures is justified. ESMA might also consider that other competent authorities should take such measures. If a national regulator decides to take measures contrary to an ESMA’s opinion it would be required to fully justify its decision. Then, ESMA would consider whether to use its intervention powers. Such intervention powers are based on the ESMA’s regulation, which allows the agency to “temporarily prohibit or restrict certain financial activities that threaten the orderly functioning and integrity of financial markets.”
Under the Financial Services Act 2010, the Financial Services Authority has powers to take action against short selling and to impose a disclosure regime on equities. However, Article 28 has conferred on ESMA intervention powers in exceptional circumstances. This provision allows ESMA to adopt measures that are legally binding on the EU Member States’ financial markets where there is a threat to the orderly functioning and integrity of financial markets or to the stability of the whole or part of the financial system in the EU.
Under Article 28 (1) ESMA has the power to require investors (natural or legal persons) who have net short positions in relation to a specific financial instrument to notify a competent authority or to disclose such position details to the public. It may also forbid or impose conditions relating to investors from entering into a short sale or into transactions relating to financial instruments or limit the value of transactions in the financial instrument that may be entered into. The Government has noted that this provision provides ESMA with several choices, as to which measures to impose that can have major economic and financial policy implications.
Under Article 28 (2) ESMA has the power to take such measures if they are necessary to address a threat to the functioning of financial markets or the stability of the EU financial system, if the situation has cross border implications and if the competent authorities have not taken measures or the measures taken were not adequate to address the threat. The Government believes that ESMA’s decision as to whether these criteria are met entails ‘a very large measure of discretion’. Moreover, the Government noted that ESMA could be required to take “potentially controversial decisions” while deciding whether or not competent authorities have taken measures which address a threat or have taken measures which do not adequately address the threat, which will entail ESMA’s involvement in the implementation of actual economic policy.
Article 28 (3) requires ESMA to take into account “the extent to which the measure:
significantly addresses the threat to the orderly functioning and integrity of financial markets or to the stability of the whole or part of the financial system in the Union or significantly improves the ability of the competent authorities to monitor the threat;” According to the Government ESMA enjoys wide margin of discretion when deciding how to take into account such factors and which measures to impose. The Government is particularly concerned that such decisions will require an analysis of the significant economic policy implications, including the impact on liquidity and the level of uncertainty that will be created in financial markets.
ESMA is, therefore, empowered to adopt measures with direct effect, limiting or forbidding short selling. Thus, any measure adopted by ESMA will prevail over any previous measure taken by a national regulator. In fact, Article 28 (3) specifically states, “A measure adopted by ESMA under this Article shall prevail over any previous measure taken by a competent authority under Section 1.” Hence, in the abovementioned situations, ESMA would be able to override measures taken by national regulators on short selling. Esma’s powers would impinge on sovereignty over national economic policy. It is unacceptable that ESMA is empowered to take policy decisions.
In May 2012 the Government launched a judicial challenge (an action for annulment) to the Short Selling Regulation on the grounds that it confers too much discretionary power on the European Securities and Markets Authority. George Osborne in his speech to the Open Europe Conference said “To establish the right principles, we have been taking an increasing number of cases to the ECJ – which is not something that we do lightly.” He moreover said, “We’re going to court over the financial transaction tax, the bonus cap and short selling as well as the action I mentioned against the ECB on clearing houses.” He then pointed out “Far from being unthinkingly anti-European, we are using the European court to enforce European principles of non-discrimination and adherence to European law.” He noted, “We have a good argument in all these cases. The ECJ’s advocate general, and the Council Legal Services have on separate occasions both agreed with key UK arguments.” However, the ECJ has ruled against the UK.
On 22 of January the European Court of Justice delivered its Judgment in Case C-270/12 United Kingdom v Parliament and Council. The Court has rejected all the four UK’s pleas, consequently it has dismissed the action in its entirety. The Court found the power of the European Securities and Markets Authority to adopt emergency measures on the financial markets of the Member States in order to regulate or prohibit short selling compatible with EU law. Hence, it has confirmed Esma powers to override national financial supervisors to regulate or prohibit short-selling.
The Government was seeking annulment of Article 28 of the regulation whereby ESMA has been granted intervention powers in exceptional circumstances. As above-mentioned, ESMA has the power to forbid or impose conditions on the entry by persons into short sales or to require them to disclose such positions if the transactions have been considered a threat to the functioning and integrity of the financial markets, or to financial stability with cross-border implications. The Government believes that such provision is unlawful since the criteria it provides for ESMA to take action involve great discretion. The Government believes that Article 28 entails ESMA’s involvement in making policy choices in the form of decisions on macroeconomic policy. Furthermore, stressing that ESMA enjoys a broad discretion as to the application of the policy in question, the Government argued that Article 28 of Regulation No 263/2012 is bound by the principle established in Meroni v High Authority. Article 28 delegates too much power to ESMA, in breach of the Meroni principle. Britain has been relying on this principle to prevent EU institutions overstepping their mandate and extending its powers. However this argument has now been overturned by the ECJ and a new precedent has been opened.
The ECJ firstly noted that “the bodies in question in Meroni v High Authority were entities governed by private law, whereas ESMA is a European Union entity, created by the EU legislature”. Then, the Court noted that the powers Article 28 of Regulation No 236/2012 “does not confer any autonomous power on that entity that goes beyond the bounds of the regulatory framework established by the ESMA Regulation” and that “unlike the case of the powers delegated to the bodies concerned in Meroni v High Authority, the exercise of the powers under Article 28 of Regulation No 236/2012 is circumscribed by various conditions and criteria which limit ESMA’s discretion.” The Court rejected the UK’s claim as it concluded “the powers available to ESMA under Article 28 of Regulation No 236/2012 are precisely delineated and amenable to judicial review in the light of the objectives established by the delegating authority. Accordingly, those powers comply with the requirements laid down in Meroni v High Authority. The Court found that “those powers do not, therefore, imply that ESMA is vested with a ‘very large measure of discretion’ that is incompatible with the FEU Treaty for the purpose of that judgment.”
The Government has also argued that under Article 28, ESMA is allowed to adopt quasi-legislative measures of general application, which breaches the principle established in Case 98/90 Romano. However, the Court said “It is clear from Article 28 of Regulation No 236/2012 that ESMA is required, in strictly circumscribed circumstances, to adopt measures of general application under that provision” which may “include rules affecting any natural or legal person who has a specific financial instrument or specific class of financial instruments or who enter into certain financial transactions.” The Court pointed out “the first paragraph of Article 263 TFEU and Article 277 TFEU, expressly permits Union bodies, offices and agencies to adopt acts of general application.” In fact, the Court noted that EMSA “may also be required, under the powers conferred on it by that provision (Article 28), to take decisions directed at specific natural or legal persons.”
Moreover, the Government noted that Articles 290 TFEU and 291 TFEU govern the delegation of powers to the Commission and argued that the Council has no power under the Treaties to delegate powers such as those provided for in Article 28 to a EU agency. Then the Court found that Article 28 of the regulation does not undermine the rules governing the delegation of powers laid down by the TFEU, namely Articles 290 TFEU and 291 TFEU. The Court noted that the Treaties “do not contain any provision to the effect that powers may be conferred on a Union body, office or agency” but stressed that there are several provisions “presuppose that such a possibility exists.” The Court recalled that “the legal framework of Article 28 of Regulation No 236/2012 is established, inter alia, by Regulation No 1092/2010, the ESMA Regulation and Regulation No 236/2012” and that “Those regulations form part of a series of regulatory instruments adopted by the EU legislature so that the Union may, in view of the integration of international financial markets and the contagion risk of financial crises, endeavour to promote international financial stability”. Hence, the Court found that “Article 28 of Regulation No 236/2012 cannot be considered in isolation” but “must be perceived as forming part of a series of rules designed to endow the competent national authorities and ESMA with powers of intervention to cope with adverse developments which threaten financial stability within the Union and market confidence.” According to the Court “To that end, those authorities must be in a position to impose temporary restrictions on the short selling of certain stocks, credit default swaps or other transactions in order to prevent an uncontrolled fall in the price of those instruments” and to “pursuit of the objective of financial stability within the Union.”
The Government also believes that Article 114 TFEU is not the correct legal basis for the adoption of the rules laid down in Article 28 of the regulation. The Government takes the view that Article 28 main purpose is not to authorise ESMA to take individual measures directed at natural or legal persons but to adopt measures of general application. But even if that was the case that provision is ultra vires as Article 114 TFEU does not allowed the EU to adopt individual decisions which are not of general application or to delegate to the Commission or an agency the power to adopt them. Hence, rather than being “harmonisation measures”, as provided by article 114 TFEU, the decisions directed at financial institutions overriding decisions made by national authorities are direct regulatory measures by an EU agency directed at individuals in Member States. It is important to recall that according to advocate general Niilo Jääskinen “…the outcome of the activation of ESMA’s powers under Article 28 of Regulation No 236/2012 is not harmonisation, or the adoption of uniform practice at the level of the Member States, but the replacement of national decision making under Articles 18, 20 and 22 of Regulation No 236/2012 with EU level decision making.” In his opinion “a centralised emergency decision making process that replaces the decision of the competent Member State authority, without its consent, or which provides a substitution for the absence of one, cannot be considered to be encompassed by the concept of ‘approximation of the provisions laid down by law, regulation or administrative action in Member States’ under Article 114 TFEU.” Hence, he agreed with the UK that article 114 is not an adequate legal basis for Article 28 of Regulation No 236/2012. He concluded that the Court should annul Article 28 for lack of competence and recommended the use of Article 352, which requires unanimity. However, the ECJ has not agreed with the advocate general.
The Court first examined whether Article 28 satisfied Article 114 TFEU conditions namely whether it “comprise measures for the approximation of the provisions laid down by law, regulation or administrative action in the Member States” and “have as its object the establishment and functioning of the internal market.” The Court held “the EU legislature, in its choice of method of harmonisation and, taking account of the discretion it enjoys with regard to the measures provided for under Article 114 TFEU, may delegate to a Union body, office or agency powers for the implementation of the harmonisation sought.” The Court pointed out, mentioning Case C‑217/04 United Kingdom v Parliament and Council, “that nothing in the wording of Article 114 TFEU implies that the addressees of the measures adopted by the EU legislature on the basis of that provision can only be Member States.” The Court noted that the EU “faced with serious threats to the orderly functioning and integrity of the financial markets or the stability of the financial system in the EU” has sought by adopting Article 28 “to provide an appropriate mechanism which would enable, as a last resort and in very specific circumstances, measures to be adopted throughout the EU which may take the form, where necessary, of decisions directed at certain participants in those markets.” The Court noted that the harmonisation of the rules governing short selling and credit default swaps “is intended to prevent the creation of obstacles to the proper functioning of the internal market and the continuing application of divergent measures by Member States.” Unsurprisingly, the Court concluded, “that the purpose of the powers provided for in Article 28 of Regulation No 236/2012 is in fact to improve the conditions for the establishment and functioning of the internal market in the financial field.” Consequently, the Court found “that Article 28 of Regulation No 236/2012 satisfies all the requirements laid down in Article 114 TFEU”, hence this provision “constitutes an appropriate legal basis for the adoption of Article 28.”
The Court of Justice has used, once again, its power of interpretation by expanding its previous interpretations, and extending the EU competences.
The UK has already been outvoted by the other Member States and the European Parliament, during the EU legislative process, and now the ECJ has not only confirmed but also strengthened the ESMA’s powers. The UK has been demanding for ESMA’s powers to be limited. However, the Government has not achieved what it was expecting with this challenge but the opposite. The powers of the EU financial supervisors won’t be limited but, in fact, are likely to increase. It is important to recall, as above-mentioned, ESMA will be allowed to make policy choices. The ECJ ruling will have far-reaching implications not only to the City of London’s financial services but also to the UK’s national interest.
The financial services regulation belongs to the internal market and it is therefore subject to QMV and the ordinary legislative procedure with the European Parliament. Moreover, the Commission has been extensively using article 114, which is the general legal basis for internal market legislation, to expand EU competences to the detriment of the competences of the Member States. Measures proposed under this provision are also subject to the ordinary legislative procedure with QMV required at the Council. Particularly, there has been an increase in the use of this provision in the field of financial services, since the beginning of the financial crisis. According to Alexandria Carr, a former Treasury lawyer the ECJ’s judgement “could give the new European Parliament and commission the green light to confer more powers to the regulatory supervisors”.
There is a EU’s ‘power grab’ over regulation of the British financial services industry. The Westminster Parliament has been obliged to accept the EU damaging legislation and final jurisdiction of the European Court of Justice. The European Commission will continue to proposed more legislation affecting financial services, which would be then subject to the ECJ’s jurisdiction. The situation will exacerbate with the creation of a banking union. the Commission, under the single market umbrella, will propose banking and financial regulations, for all EU member states. It is important to note that from November 2014 the eurozone will have a qualified majority. The eurozone member states, as well as other member states participating in the banking union, will vote as a block, imposing further regulations on the City of London, under single market provisions. The UK would see itself in the position of having no choice but to accept legislation without having the chance of negotiate it. The chances of the UK being able to influence EU’s policies and legislation would be even more limited. As Bernard Jenkin MP rightly noted “It is equally possible that the member states of the eurozone that are in the banking union will caucus in the Council and use a single-market measure to create a single market in banking services to reflect the policy already adopted by the banking union.”
The ECJ ruling not only raises concerns of further powers being transferred to EU agencies using this legal base but also the possibility of Brussels widening the use of Article 114. According to The Financial Times, “A European Commission spokesperson described the ECJ ruling as “significant” and “important” as it vindicated the use of a single market legal base”. The Commission will further use single market rules to expand EU powers over financial services. It is possible to argue that the ECJ by making a broader interpretation and authorising a widener use of Article 114 might create the necessary conditions to eurozone member states to use this as well as other single market provisions to pursue their own interests to the detriment of the UK as well as other non-eurozone countries.
As Alex Barker said in The Financial Times, “While the full consequences remain uncertain, the court’s findings may also give Brussels more legal space to pursue integration for the eurozone, without needing to open the treaty renegotiation sought by UK Prime Minister David Cameron.” Alexandria Carr also noted “It is likely to cause concern in the UK and some other member states, including Germany, which are already uneasy with the way in which the EU’s legal framework is being stretched as the EU seeks to confer wide new powers on EU bodies whilst avoiding the thorny question of whether this actually necessitates treaty change.”
George Osborne has been launching legal challenges at the ECJ to limit the impact of the EU financial regulation in the UK. Taking into account the role of the European Court of Justice in interpreting the Treaty and that the ECJ has been the motor of EU integration, the Government is taking a huge gamble with these challenges, as the ECJ is most likely to decide against the UK, as it did, and in favour of further integration extending the EU competencies. Rather than seeking to protect UK national interest through the ECJ the Government should protect the UK from the ECJ’s judgments. The Government has failed, so fair, to address constitutional issues, particularly the assertion of European Union institutions that they have ultimate jurisdiction over UK law-making. The Government ability to protect national interest has been progressively restricted. The United Kingdom will no longer be able to insist upon retaining its own control over financial services and banking in the City of London. These issues can only be addressed by renegotiating all the EU Treaties and the whole relationship with the EU.
The ECJ ruling clearly shows the need to adopt, as soon as possible the European Scrutiny Committee proposals. The European Scrutiny Committee Report on Reforming the European Scrutiny System in the House of Commons not only recommends the introduction of a unilateral veto but also disapplication of EU legislation notwithstanding the European Communities Act 1972. It is important to recall that Bill Cash’s Sovereignty Bill implements the ESC’s proposals. The Bill introduces a unilateral veto over EU legislative proposals and includes clauses on disapplication that will enable Parliament to disapply legally binding European Union measures. Bill Cash’s Sovereignty Bill would be a fundamental instrument to defend Britain’s national interest.
