A.  Introduction

  1.  This memorandum is submitted by the Financial Services Authority in the context of the Committee's Inquiry into the European Commission (EC)'s review of the single market. We look forward to elaborating on it in oral evidence on 25 June.

2.  The memorandum:

—  provides brief background on the FSA, including its scope and overall approach to regulation;

—  outlines the FSA's approach to implementing EU legislation;

—  provides background on the Financial Services Action Plan (FSAP), and on our approach so far to the Markets in Financial Instruments Directive (MiFID); and

—  answers the specific financial services questions the Committee has asked in its call for evidence.

  3.  The Financial Services and Markets Act 2000 (FSMA) gives us four statutory objectives: to maintain market confidence; to provide the appropriate degree of consumer protection; to promote public understanding of the financial system; and to reduce financial crime. In carrying out our general responsibilities we must also have regard to seven statutory principles, including the international competitiveness of the UK, proportionality, and facilitating innovation and competition.

  4.  We have translated these four statutory objectives into three strategic aims which guide our day-to-day work:

—  helping retail consumers achieve a fair deal;

—  promoting efficient, orderly and fair markets, both retail and wholesale; and

—  improving our business capability and effectiveness.

C.  The FSA approach to EU Legislation

  5.  Negotiation of European legislation and, ultimately, its implementation in the UK are responsibilities of HM Government. The vehicle for implementing many of the provisions in Directives affecting financial services is FSA rules. For this reason we work very closely with the relevant Government Departments (mainly the Treasury) in the relevant EU fora.

  6.  Our approach to implementing directives is one of "intelligent copy-out"; we do not add to directive requirements unless there is a proven market failure and the proposal is justified by cost-benefit analysis. Furthermore, we subject existing requirements which go beyond those in a directive to the same disciplines.

D.  Background on the FSAP and the FSA's approach to MiFID

  7.  The FSAP legislative programme has come to an end. It was published by the Commission in May 1999 and endorsed by the Lisbon European Council in March 2000. Its purpose was to produce a set of measures creating a legal and regulatory environment to support the integration of EU financial markets by 2005. It consists of 42 measures, including 24 EC Directives to be transposed into the law of each Member State, and Regulations, which apply directly in all Member States.

  8.  The FSAP has three specific objectives:

—  to create a single EU wholesale market;

—  to achieve open and secure retail markets; and

—  to create state-of-the-art prudential rules and structures of supervision.

  These objectives are designed to promote Europe's wider economy by removing barriers and increasing competition among financial services firms, thereby making markets more efficient and reducing the cost of raising capital to industry generally.

  9.  In accordance with our general approach to EU legislation, in implementing MiFID in the UK, we have sought to use "intelligent copy-out" of the Directive text. This should avoid placing unintended additional obligations on firms. After careful consideration and cost-benefit analysis, and as provided for under the implementing Directive, we are proposing to retain a small number of existing requirements of importance to our national market in the UK; these have been agreed with the European Commission. But we are not seeking to "gold plate" the provisions in MiFID by introducing new rules which are "super equivalent".

  10.  The success of the single market will depend in part on the agreement of proportionate and effective arrangements for the supervision of EU-wide groups and their activities—so called "home/host" issues. Such arrangements are necessary to minimise costs arising out of duplication where firms operate in several jurisdictions. European directives tend to be reasonably clear about where supervisory responsibilities lie and the FSA has been in the forefront of advocating greater streamlining of arrangements for EU-wide insurance groups by centralising responsibility in the "home" country where the parent is authorised. There is a need, however, to make further progress in the area of day-to-day collaboration among supervisors; that is how tasks can most efficiently be allocated to ensure that supervision is both effective and efficient. We believe that the details of such arrangements need to be agreed among the supervisors concerned on a case-by-case basis, taking account of factors such as the impact of a branch or subsidiary in the market in which it operates.

  11.  A recent area of contention has been the allocation of home and host obligations under MiFID. Compared to the preceding directive in this area, the Investment Services Directive, MiFID has greatly increased the level of certainty, removing all responsibility from the regulator in the country of the customer, and making the home state responsible for the operation of systems and controls in branches in other Member States. One area where some uncertainty remains, however, concerns responsibility for monitoring and enforcing compliance of certain MiFID conduct of business requirements where a service is provided by a branch to a customer in another EU country. Our aim is, in the interests of firms and consumers, to ensure clarity and transparency on where responsibilities lie. Discussions are continuing on this issue and whatever the outcome, there will necessarily have to be a high level of regulatory co-operation and collaboration.

  12.  More generally, increasing the level of effective cooperation between national regulators, within the EU and globally, is a key priority for the FSA. A particular focus of our effort in recent years has been directed to supporting three committees of national regulators in the financial services sector—the so-called "Lamfalussy Committees"—the Committee of European Securities Regulators (CESR), the Committee of European Banking Supervisors (CEBS), and the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS).

  13.  These committees advise on proposed legislation and on developing supervisory convergence. To date they have focused largely on the FSAP and the related legislative measures. However, the increasing activities of internationally active firms and the greater range of responsibilities given to the home regulator under FSAP require national regulators greatly to increase the level of de facto day-to-day co-operation. All three Committees have work plans in this area. These include setting up "colleges" of supervisors for individual firms and groups, and allocating supervisory tasks to the regulators best placed to carry them out. The Committees are also planning to enhance their collaboration on policy issues, including developing guidelines on good practice and increasing the level of joint working, for example on impact assessments.

  14.  One important means of promoting regulatory convergence throughout Europe is providing training for regulators and establishing a forum for them to exchange views on practical supervisory issues. A platform for this is being created under the joint auspices of the Lamfalussy Committees. The FSA strongly supports this initiative and has been in the forefront of developments here.

E.  What has been the impact of the implementation of the Financial Services Action Plan as a whole; and in particular the Markets in Financial Instruments Directive?

The FSAP

  15.  Greater harmonisation is a necessary condition for removing national barriers to competition. Replacing national regulatory standards with predominantly EC ones has been costly, with firms having to make a significant number of systems changes.

  16.  Only when the barriers to the single market are finally removed will it be possible to assess the benefits of the FSAP to Europe's wider economy. The Commission is committed to undertaking a thorough assessment of the FSAP. The Commission's White Paper on future financial services policy 2005-10 contained the following commitment:

"Ex-post evaluation of the FSAP and of all new legislative measures is a top priority for the Commission in the coming five years. By 2009, the Commission will endeavour to have completed a full economic and legal assessment of all FSAP measures. A study will be launched in the course of 2007-08. Evaluations of the key measures will take place around four years after the implementation deadline of each measure."

"If—over time—careful assessment and analysis reveal that specific legal texts have not worked, they will be modified or repealed in the framework of the legislative procedure."

  17.  The Commission has embarked on a two-part evaluation of the FSAP. The first, on which it has consulted, was to evaluate the process of negotiating and adopting the 42 FSAP measures. The second, which the Commission is now taking forward, is an economic analysis of the FSAP, to see what effect the measures have had across a range of European markets. The Commission is likely to appoint economic consultants to undertake this analysis in the near future.

  18.  Since firms can take advantage of the MiFID freedoms only from November 2007 (and are also currently engaged in implementing the Capital Requirements and Transparency Directives), it is too early to assess the full costs of the programme across all 27 Member States, let alone the benefits to the economies of Europe attributable to the FSAP. This is particularly the case since very few other Member States have a requirement to undertake a CBA or an impact assessment as part of the implementation process. Those reports which have attempted to assess the impact of the FSAP inevitably, therefore, present a picture in which not all the costs across the EU are estimated, and where the data on costs dwarf those available for the benefits.

MiFID

  19.  In a range of consultation papers issued over the last two years, we have included detailed cost-benefit analysis on all the substantive rule changes we proposed in relation to MiFID, including where those measures are prescribed by the Directive. In addition, in November 2006 we published the results of a separate strand of work, setting out our assessment of the overall costs and benefits for the financial services industry of implementing MiFID in the UK, The overall impact of MiFID.

  20.  The paper indicated that, under certain assumptions, MiFID could generate some £200 million per year in quantifiable ongoing benefits, which will be attributable mainly to reductions in compliance and transaction costs. MiFID could also generate another £240 million benefit in "second round" effects (a reduction in the cost of equity and consequent effect on GDP) that flow from deeper and more liquid capital markets, benefiting the economy as a whole. The quantified one-off costs of implementing MiFID could be between £870 million and £1 billion, with ongoing costs of £88 million to £117 million a year. These are aggregate figures: it is likely that the distribution of costs and benefits will vary among firms depending on exactly how MiFID affects their business. We are encouraging firms to focus on the opportunities that MiFID presents over the longer term.

  21.  Ultimately, the impact of MiFID needs to be judged in an EU-wide context; benefits for less developed financial markets are likely to be more significant in relative terms that for fully developed markets like the UK.

F.  Do you support the Commission's Code of Conduct on Clearing and Settlement?

  22.  We support the Commission's decision to pursue an industry code of conduct as a means of improving the effectiveness and efficiency of clearing and settlement, particularly on a cross-border basis. Indeed, we joined with the Treasury and the Bank of England in actively promoting such an outcome, in preference to a Directive.

  23.  The Giovannini reports prepared for the Commission in 2001 and 2003 concluded that cross-border clearing and settlement arrangements are complex and fragmented, and give rise to inefficiency and higher costs. The Commission subsequently began a process of examining ways of improving the operation of clearing and settlement infrastructure at the EU level, in consultation with Member States and market stakeholders. In relation to legislation, the Treasury, Bank of England and the FSA noted in the joint response we made to Commission's 2004 communication on clearing and settlement that: "The case for a Directive needs to be clearly made. It is important to be very clear about the problems for which a Directive would be the best solution." The UK authorities also stressed that any Commission initiatives in this area must be based on a thorough analysis of the costs and benefits of any policy proposals.

  24.  Commissioner McCreevy announced in July 2006 that the Commission would be initiating a code of conduct in preference to a Directive. He noted that the structure of trading, clearing and settlement in the EU would continue to evolve as integration accelerates, and that a regulatory measure at this stage could slow down or even block the restructuring process that is already underway.

  25.  The code, as agreed with market participants, covers measures on: greater transparency of prices (to have been implemented by the end of 2006); enhanced access between different providers, and principles for inter-operability (for implementation by the end of June 2007); and greater unbundling of the provision of specific services (for implementation by the beginning of 2008). Looking to the future, we believe that it is important that the code is appropriately monitored, so that the benefits which could flow from it are secured in practice.

20 June 2007