ECJ throws out UK's FTT challenge, raising questions about whether it can be trusted to police the EU treaties

This morning’s ECJ judgement that the UK’s legal challenge against a proposed Financial Transaction Tax (FTT) is premature was what many had expected. The UK had challenged the decision to authorise the use of so-called ‘enhanced cooperation’ (where a smaller group of EU members can move ahead with legislation even if it does not have broader EU support) for the FTT. For the UK Government, today’s result is not what it had hoped for (an annulment of the decision to authorise enhanced cooperation), but neither is it the worst outcome.

Today’s ruling effectively said that the court could not rule on the UK’s substantive objections to the FTT since the final shape of the tax is unknown and subject to further negotiation between those taking part. This does not prejudice the UK’s ability to mount a second challenge once the final FTT has been agreed and its implications are clearer.

The ECJ judgement (in full here) said:

“It is clear that the objective of the contested decision is to authorise 11 Member States to establish enhanced cooperation between themselves in the area of the establishment of a common system of FTT with due regard to the relevant provisions of the Treaties. The principles of taxation challenged by the United Kingdom are, however, not in any way constituent elements of that decision.”

“The two pleas in law relied on by the United Kingdom in support of its action must be rejected and, accordingly, that the action must be dismissed.”

“Those effects are dependent on the adoption of ‘the counterparty principle’ and the ‘issuance principle’, which are however not constituent elements of the contested decision, as stated in paragraph 36 of this judgement.”

“That review should not be confused with the review which may be undertaken, in the context of a subsequent action for annulment, of a measure adopted for the purposes of the implementation of the authorised enhanced cooperation.”

However, while the UK will get a second stab at challenging the FTT, today’s ruling poses major questions about how ‘enhanced cooperation’ works and how it is used in the future. The EU Treaties stipulate that authorisation of enhanced cooperation (which is given by a qualified majority vote of all EU member states) is conditional on the proposed legislation respecting the integrity of the single market and not impacting on those not taking part – this is meant to be a legally enforceable safeguard for those countries not participating.

Enhanced cooperation is a relatively new phenomenon that has only been used twice before (for a European Patent Office and divorce law), but it could have huge implications for the future of the EU and Britain’s place within it. In an increasingly multi-tier EU, enhanced cooperation may be used more often by countries that want to integrate further. For those that don’t wish to follow suit, it is vital that their rights in the single market are respected.

Let us start with an analogy. Imagine you had agreed to let your neighbour build a new house based on a certain agreement and set of plans. Halfway through building it becomes clear that he has adopted a new plan which will hamper your view or infringe on your land. You appeal to the council but they rule that it is too soon to tell where the house will end up and that they can only rule when the house is built. Tearing down a house is much messier and more costly than stopping one being built in the first place. Hardly seems efficient or fair, does it?

Yet, in this case, this seems to be what the ECJ has done. It has effectively decided that it could not decide whether the decision to authorise the FTT proposal does respect the rights of those not taking part because the final outcome of the FTT negotiations cannot be known now. This is strange because this is by definition true in pretty much all cases of enhanced cooperation, since the countries involved negotiate the finer points of the legislation amongst themselves after getting approval to go ahead.

While this may seem legalistic and technical it raises a fundamental question: are the authorisation criteria for enhanced cooperation worth anything? Surely, any decision on the use of enhanced cooperation should be made on the basis of the proposal that is on the table, irrespective of whether it might change (for the better or worse) by the time it is finally agreed as a legal act, which could still be challenged in any case. The potential spill-overs should be examined before those member states not involved give those involved the go ahead. Otherwise they are ultimately authorising an unknown piece of legislation, which once it has built up a political head of steam could be much harder to challenge later on.

By its very nature, enhanced cooperation will be used for controversial proposals but today’s ECJ judgement has increased uncertainty surrounding this procedure (it was already uncertain) and undermines the logic of the process for authorising its use. We cannot know what the long term implications of this will be for the EU and the UK but they could be important.

As for the FTT, the UK will have another chance to challenge the final legislation (which may end up being watered down anyway due to concerns from those taking part) but by the time it gets to that point, there will be so much political capital invested in it, it may make it harder for the court to strike it down, even if the UK has good legal grounds.

The Battle of Londongrad? What does the data actually say?

On Friday afternoon Open Europe released a new flash analysis looking at the links between the City and Russia.

Much has been written on this issue – see NYT, FT and Economist for background.

While there is anecdotal evidence in these articles about City links to Russia, they fail to delve deeper into the data and, importantly, lack any context as to what Russian business means to a city and financial services sector the size of London.

The summary of the piece argues:

“Claims that the City of London would suffer major losses in case of financial sanctions against Russia are overblown. While it is true that there are some sizeable Russian investments in London, and it is home to a disproportionate number of Russian oligarchs, these are far from critical to a global financial centre such as London. The stock of Russian international investments in London is sizeable at £27bn, but it only accounts for 0.5% of total European international assets invested in London.”

“For all the talk of the large number of financial services provided to Russia, these only amount to 1% of total UK exports of financial services, business services and insurance. This would suggest that accusations that the UK Government is blocking tougher sanctions over fear of losses to the City don’t match the facts.”

“Sanctions related to financial or capital markets, for example severing access to credit for state-owned enterprises or Russian banks, might be an effective strategy to exert more pressure on Russia (given its reliance on external financing). Such move would be far more damaging to Russia than the City of London – though it may involve some losses for the latter. This should not, and does not seem to be, a big concern for the UK government. In any case, if things get to this stage, other EU countries may suffer far greater losses than the UK through wider economic sanctions hitting, for example, gas supplies and exports.”

There are plenty of factors to consider when looking at sanctions. While the City is one of them, in the scheme of the broader European links to Russia it does not seem huge (compared to some economies complete energy reliance). Furthermore, given the size of the City as a global financial centre the links to Russia seem to fall far short of the critical billing they seem to have been given.

What would leaving the EU mean for the UK's services sector?

Our Director Mats Persson writes on his Telegraph blog,

The UK’s services sector accounts for around 75 per cent of the country’s GDP. Britain’s 0.6 per cent growth in the second quarter of this year was largely thanks to this sector, which grew at its fastest rate in over two years.

Whether we like it or not, the UK will remain a services-based economy for a very long time. So it goes without saying that as David Cameron looks to negotiate a new settlement with Europe, getting a good deal for the UK’s services sector should feature highly.

By far the most common argument from Better Off Outers is: “We sell more to them than they sell to us”, implying that the UK’s trade deficit would give London leverage to secure a favourable Free Trade Agreement in place of EU membership. It’s a persuasive argument. It is also simplistic. As the graph below shows (click to enlarge), the UK’s trade deficit with the EU is the result of a large goods deficit, while it is a net exporter of services.

This is critical for several reasons.

First, UK services firms clearly use their comparative advantage to do business in Europe, boosting UK growth.

Secondly, if you buy into the “trade deficit” argument, it follows that while Germany and others would have an interest in maintaining open markets for selling manufactured goods in the UK, this logic does not apply for services, where they are net importers from the UK.

Therefore, the UK would be vulnerable to tit-for-tat trade games in its key economic sector. Perhaps Germany would be so keen to continue selling tariff-free cars that it would happily offer market access for UK services firms as part of a new deal. However, it’s far easier to remove tariffs for goods than it is to eliminate the myriad of barriers that exist to market access in services. Despite 40 years of negotiations, the Swiss still have patchy EU market access for services, while the EU and US have spent decades trying but failing to agree reciprocal market access for certain types of funds.

Critically, there’s only one off-the-peg model offering full market access for services outside the EU – the Norwegian model (EEA) – which for a range of other reasons would be a bad deal for the UK. The other potential models – the Swiss, Turkish and WTO options – would restrict access for the UK services industry absent separate agreements for specific sectors. This also spells problems for the City of London, currently used by a range of firms as an entry point to the single market, often via a so-called passport (involving a firm being allowed to sell its services across the EU as long as it’s authorised to do so in one member state).

Again, given that the City is also a gateway to global markets for European firms, a deal might be struck. However, since “Anglo-Saxon” bankers and fund managers aren't exactly universally loved on the continent, it’s also easy to see France et al blocking passport-style provisions for UK financial firms in perpetuity.

So, there’s a strong argument for the UK to remain a full member, not only of the single market in goods, but also in services. Now, this cost-benefit analysis could of course change. For example, if the many non-trade costs of EU membership aren't reduced through fundamental reform; if the single market in services – which is under-developed – continues to be held up by protectionist interests; if the EU prevents the UK from taking advantage of growth opportunities from around the world; if Brussels continues to be more interested in restricting financial services activity rather than facilitating trade – then the case for fully remaining in the single market could weaken significantly.

Which is why another round of serious liberalisation of the EU services market is long overdue. Over to you, Berlin.

The triple challenge behind EU move to cap banker bonuses

In a comment piece in yesterday's Sunday Telegraph - trailing today's meeting of EU finance ministers that can seal the deal on capping banker bonuses - Mats Persson looks at the three challenges that form the backdrop of this discussion: 

• The mis-match between the relative importance of financial services to the UK and its limited voting weight in the EU's decision-making machine
• The tendency of EU politicians to engage in displacement activities and avoid tackling the root causes of the banking (and eurozone) crisis
• The "out of the euro but run by the euro" risk created by the creation of an EU banking union

Here's the article:

With this week’s well-publicised European Union move to cap bank bonuses, the UK now faces the prospect of being outvoted on a major piece of EU financial law for the first time. This may only be the beginning.

Fundamentally, the EU’s voting system – where almost all financial laws are decided by majority voting – leaves the UK vulnerable. While the UK accounts for 36pc of the EU’s financial wholesale market and 61pc of the EU’s net exports in financial services, it has only 73 out of 754 seats in the European Parliament and 8.3pc of votes in the Council of finance ministers. That trade-off is acceptable as long as the UK wields significant influence over EU rules – with the City serving as a global entry point to the single market, which is still does. In the 1990s and 2000s, this model served the UK well, with most EU laws aimed at facilitating trade.

Unsurprisingly, the focus of EU regulation started to change in 2008 with the financial crash. Of the 50 or so EU financial measures currently floating around, only a handful are aimed at boosting trade, most are about limiting or controlling financial activity in different ways – some of them fully justified. For many EU politicians and governments it is convenient to see the financial crash – and by extension “Anglo-Saxon capitalism” – as the fundamental cause of the eurozone crisis. Bank bonuses and the financial transaction tax, they say, help tackle excessive risk-taking and, therefore, the eurozone crisis.

This is ironic, since the same governments have simultaneously resisted many measures that would address systemic threats – such as sufficiently robust capital requirements and liquidity rules and enforcing losses on creditors. The EU has supported and approved €4.6 trillion (£4 trillion) in taxpayer-backed aid to banks over the course of the financial crisis. To think that capping bonuses will address moral hazard against trillions of state aid, borders on the bizarre.

What lies behind this self-delusion? A deliberate attempt to kill the City and drive business to Frankfurt and Paris? To some extent, but much of the motivation is, in fact, displacement activity. The tough sweeping reforms really needed to stabilise Europe’s financial sector – such as recapitalising or restructuring regional banks – often clash with regional or local politics or economics. But as politicians cannot be seen to do nothing, they take the easy route: we may not be able to create a mechanism to wind down banks but we can tell voters that we have limited the bonuses of greedy bankers. This invariably puts the City in the firing line, as that is where most of the bankers are.

This is exacerbated by a third problem – the City is a trading hub for a single currency of which the UK is not a member. The emerging union of EU banking, designed to align a supra-national currency with an interconnected banking system, creates incentives for euro states to collude in writing common financial rules that risk the City gradually being pushed “offshore”. The European Central Bank has already demanded that transactions cleared in euros move to the eurozone, which the UK has challenged in court. If we lose, it would lead to a two-tier single market, with a protectionist eurozone bloc – and trillions of euros worth of transactions could leave London.

The UK Government has taken steps to ensure a competitive financial services sector against the backdrop of an EU banking union. But the City and the finance sector are on the front line of the EU debate. If this hub of economic activity becomes a casualty, how could a UK government still defend EU membership? 

The FT today needs two separate comment pieces (behind pay wall) to make the same points - but worth a read nonetheless.