ECJ rules against the UK in landmark short-selling case

The ECJ this morning rejected all the UK’s claims against the EU's short selling regulation. The result was surprising given that the Court's Advocate General Niilo Jääskinen issued an opinion supporting the UK’s position last September – court rulings often, but not always, follow these opinions.

The nub of the UK's complaint was that the new regulation transferred too much discretionary power to ESMA (the European Securities and Markets Authority) to ban short-selling over the heads of national regulators. And that the legal base for doing so in the EU treaties was unsatisfactory. The case could therefore set an important precedent.

The UK’s complaint as described by the court:

The United Kingdom contends, inter alia, that ESMA has been given a very large measure of discretion of a political nature which is at odds with EU principles relating to the delegation of powers. The United Kingdom also submits 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 full regulation and article 28 can be found here.

Here is what Jääskinen had to say about the complaint in September:

"The outcome is not harmonisation but the replacement of national decision-making with EU level decision-making. This goes beyond the limits of Article 114."

While he didn’t side with the UK on all issues, he did recommend changing the legal base of the regulation to Article 352, which would have given the UK a veto.

However, the ECJ took a very different line arguing that the regulation is in line with the treaties since ESMA already has a role to play in this area and because the powers are limited to times when financial market stability is in question - of course when this is, remains to be defined by ESMA itself. The court also suggests that, contrary to the Advocate General's view, the new rules do provide for harmonisation.

As we noted before, this ruling has the potential to be very important for the UK and could set the tone/precedent for future rulings. The court’s decision to reject the UK’s claim could have some important implications:

• Firstly, it potentially sets a precedent for the transfer of powers to an EU agency under the single market article (114). This is decided under qualified majority vote (QMV) meaning the UK does not have a veto. Not only that, but the scope of the powers remains vague and widespread, allowing ESMA quite a significant amount of leeway in deciding where to act in what the UK Government would argue are political decisions.

• More generally, there will be a concern that it could allow the use of Article 114 to be stretched – a question which is raised in some of the UK’s other on-going court challenges against EU financial regulation.

• This will raise concerns in the UK over two issues – financial services regulation and the split between euro and non-euro countries. The first is obvious given that the UK may feel its ability to legally protect itself against burdensome regulation is now diminished. The second stems from the potential abuse of the single market article to further the needs of the eurozone - the short-selling ban was largely conceived following the eurozone/financial crisis to combat 'speculators'.

• One saving grace may be that the ruling is quite specific in terms of financial market oversight, a role which the agency in question (ESMA) already has a part in. However, only time and future legal challenges will tell far-reching the implications of this ruling will be.

What happens now?

Given that the ECJ rejected all aspects of the UK's claim, it is dismissed entirely. There is little more the UK can do from a legal aspect, unless it decides to challenge other parts of the regulation but that seems unlikely.

The UK can continue to work behind the scenes to limit the practical power of ESMA and define strict criteria for when it can act on this issue. Of course, if any decision to limit short-selling by ESMA does happen, it could always challenge that specific move.

Nevertheless, this is clearly a political blow to the UK.  

ECJ legal opinion marks important preliminary victory for UK in short selling dispute

The UK has this morning been set on the path to an important victory at the European Court of Justice, after the Advocate General Niilo Jääskinen supported the UK’s claim that the EU's short selling Regulation transfers too much power to the European Securities Markets Authority (ESMA).

The opinion is not binding, but is followed in the majority of cases.

The UK objected to the EU's short selling regulation on a number of levels, but the main concern was that Article 28 of the Regulation - which allows ESMA to impose temporary short selling bans in emergency situations, overruling national financial supervisors - amounted to a significant transfer of power to an EU institution, and therefore Article 114 of the EU treaty (the single market article) was not a valid legal base for the Regulation.

The Advocate General did not side with the UK on all points, but on this key issue, he said:

"The outcome is not harmonisation but the replacement of national decision-making with EU level decision-making. This goes beyond the limits of Article 114."

Jääskinen went on to suggest that an alternative legal base for the regulation could be found and recommended Article 352 of the EU treaties. Although this may seem a technical point, it is extremely important. Article 352 (which sets out the so-called 'flexibility clause') requires unanimity, meaning the UK could veto the proposal.

If the ECJ were to follow the advice of its Advocate General, this could prove to be an important ruling for a number of reasons:

• First, it would halt the transfer of further powers (without national permission) to an EU agency and allow the UK to keep control over an important part of financial services regulation;
• Secondly, it would show that the UK government can have success using the right legal channels effectively. This could bode well for other cases, such as the on-going dispute on UK rules on EU migrants’ access to benefits, or ECB demands that transactions denominated in euros be cleared exclusively within the eurozone;
• It also highlights that the single market article, which, as we noted before, has been stretched significantly, cannot be a ubiquitous catch-all legal base for things the Commission believes fit with its view of the single market. This could become important in future negotiations, particularly over banking union.

Half Time score on EU short selling regulation: Common sense 1, Poltical motives 1

Pardon for this uncharacteristically jargon-heavy blog-post...

Following our event on the proposed EU regulation of short selling in March, we expressed our concerns that political motives were trumping common financial sense at that point in the negotiations (based on the European Parliament’s proposal). It looked as if certain EU politicans had got one over on the markets (or so the politicans would like to present it) with a proposed ban on uncovered credit default swaps (CDS) and extending a ban on naked short selling to the sovereign debt markets.

Now, having examined the latest proposal to come out of the recent meeting of EU finance ministers, its looks as if the common sense is slowly gaining some ground back.

For starters, they’ve left CDS largely alone, apart from a clause which allows CDS activities to be temporarily banned in exceptional circumstances if all national regulators agree (which gives the FSA an effective veto).

The proposal still bans naked short selling (as it was ultimately designed to do), including sovereign debt, but this can be rescinded if it is seen to harm liquidity in sovereign debt markets. Interestingly, short selling of sovereign debt is allowed if it is seen as hedging against a corresponding long position. The European Securities Market Authority (ESMA) is mostly given a coordination role, it can attempt to rescind or extend the ban on an EU-wide basis but, again, it requires the consent of national authorities to do so.

The transparency rules are still included, stating that any investor with a significant net short position in shares must disclose it to regulators and to the markets if above a certain threshold. Importantly, this has been watered down in reference to sovereign debt so that no public disclosure is necessary. Public disclosure of short positions isn't uncomplicated but ultimately its impact will depend on the exact threshold levels and the format in which it is disclosed, both details which are yet to be announced.

Clearly, the Council's proposal is better than what some countries, such as France, had pushed for, particularly in relation to sovereign debt. It looks as if, at least in this round of the negotiations, the common sense approach - not least in terms of avoiding cutting off sources of liquidity for struggling eurozone countries - has been taken to heart. However, the negotiations are far from over, with the European Parliament still pushing for its far tougher proposal.

Member states and MEPs will now have to try to find a compromise between their respective proposals (with some member states no doubt using those negotiations trying to win back concessions that they horse-traded away - that's the nature of co-decision and Qualified Majority Voting).

So while this is pretty good news, it's only the half-time score.

A fight breaks out in a bar...

Last week we organised a debate in London on the EU's proposed short-selling rules (a summary of the event can be found here). With four excellent panellists, we covered lots of ground and managed to get into the crucial details without losing track of the bigger picture (always a challenge with what is, after all, a highly technical piece of financial legislation).

The proposal is currently gridlocked in negotiations between MEPs, member states and the Commission.

As it stands, the proposed short-selling regulation is a mixed bag - some much needed transparency measures are welcome, but some provisions on the table could be counterproductive and hurt weaker European economies . In particular, MEPs want to impose a blanket ban on short-selling of "uncovered" Credit Default Swaps on sovereign debt, to counter "speculation" against weaker eurozone economies. That the Commission, and virtually everyone else, has pointed out that there is no evidence that short-selling drives up borrowing costs for governments, seems not to matter.

MEPs insistence on a blanket ban is all about political games - it has nothing to do with economic realities. As MEP Syed Kamall (who's opposing the ban) noted at the debate - and others have noted as well - when a fight breaks out in a bar, you don't hit the guy that started the fight, you hit the one you always wanted to hit (see picture - we'd like to say that the two guys sitting down chilling are representative of the UK's approach to Europe but that might be a bit harsh, at least in this case).

We take a closer look at the proposal and state of the negotiations over on Public Service Europe. We acknowledge that,

The overarching goals of the European Union's new short-selling regulations are supposed to "create a harmonised framework for coordinated action at European level, increase transparency and reduce risks". These are commendable aims, which are also widely accepted by those within the industry.

But on the proposed CDS ban, we note

In fact, in many cases, the ability to "go short" increases investments in struggling economies since it serves to reduce risks involved in that investment – while offsetting the exposure investors may have to long positions elsewhere. Take away this form of insurance, and fund managers will grow increasingly reluctant to invest in the very economies that are in need of cash inflows.

For example, take an investor who considers putting his money into a project or enterprise in one of the eurozone economies, which is struggling to cope with large levels of debt at the moment. Naturally, he will want to have a way to hedge or insure himself against potential losses, in what is a risky economic environment. One way of doing this is to take a short position on the sovereign debt of this country in order to offset some of the risk. An excessive ban on CDS short-selling activities would reduce the flexibility of markets to respond to these kinds of risks, which in turn increases the cost of capital and reduces investments in - and lending to - struggling eurozone economies.

Alluding to the "fight in a bar" analogy, we conclude,

The biggest problem with this proposal is, therefore, that it is driven by a narrow political agenda rather than economic evidence, best practice and common sense. It is easier for politicians to accuse "speculators" - a vague group of people that is never really defined - for carrying out an evil conspiracy, than to deal with the real problems facing the EU economy. Such as low growth, an undercapitalised banking sector, an unsustainable single currency and governments spending money they do not have.

Unfortunately, in this fight it seems as if, rather than improving financial regulation, struggling European countries will be hit the hardest