The April 22 Open Hearing on the Investment Services Directive (ISD) virtually completes the external consultation process in this proposal. This series of consultations should be the model for an interactive dialogue with market participants that will enhance the chances of 'fast track' legislation commanding the support of all parties involved.
Investment Services Directive – 22 April 2002
At the ISD open hearing on 22 April, strong support was expressed about the need for a revised ISD Directive. However, after studying the details, it became obvious that views especially with regard to ‘internalisation’, ‘Alternative Trading Systems’ and ‘transparency issues’ still differ widely.
This open hearing on the forthcoming ISD proposal, marked the end of a long consultation process arranged by the European Commission. Although written responses are welcome until the end of May and even though some market participants have demanded further empirical studies, the Commission will end this process and is now expected to publish a proposal by end November /early December.
A key aspect of the debate is the degree to which “internalisation” of off-exchange executions should be allowed. Investment banks are in favour of executing orders internally. Their argument is that this will lead to greater competition in the markets and cost advantages for their clients. However, it remains to be seen how far these advantages can be achieved.
There could be negative effects on transparency and the liquidity on regulated markets. This would have corresponding negative effects on price building mechanisms. Traditional stock exchanges and supervisory authorities are sceptical about the proposal put forward by the Commission . Ex-post publication of prices may not be sufficient to ensure full transparency. Furthermore, establishing ‘indoor-markets’ might lead to fragmentation rather than integration and would thus lead to market distortions.
Opening the hearing, David Wright summarised the main issues of the new proposal:
the incorporation of new technologies, including Alternative Trading Systems;
the establishment of a single passport or home country principle; and
the clarification of supervisory and regulatory issues with regard to transparency, price-building, best execution and market structure.
The aim of the Directive is to build up an integrated European capital market and a level playing field for market participants.
Mrs Randzio-Plath, Chairperson of EMAC Committee in the European Parliament set out some of the key issues for the European Parliament:
It is of importance for the European Parliament that the change of the framework conditions for security markets and the new rules will not create competitive distortions between different types of service providers. Identical business should therefore be subject to the same regulatory and supervisory rules and mechanisms.
There is a need to establish common rules for authorisation and market access as well as for regulating trade. Given the rapid changes of products and markets, a ‘split’ of the Directive could facilitate the adoption of new market developments.
Transparency and investor protection have to be guaranteed especially concerning the regulatory treatment of off-exchange order execution.
Mrs Randzio-Plath also made it clear that the European Parliament will, in particular, focus on how the borderline between the requests from the industry and the regulatory and supervisory authorities will be drawn between different levels, and she also stated that she would listen carefully to the CESR opinions and recommendations.
Mr Hidalgo, representing the Spanish Presidency, referred to the definitions and design of the legal instruments. New technological and market developments have to be incorporated into the new Directive. However, with regards to regulation, well- defined rules have to be established, especially in relation to off-exchange order executions.
Remaining issues with regard to the quality of legislation includes the incorporation of ‘investment advice’ in the new Directive, the country of origin principle and a possible overlap with different Directives, e.g. on Clearing and Settlement issues and the Collateral Directive.
Mr Demarigny, Secretary-General of CESR, pointed our four issues that still need further examination. These are related to transparency, price-building, best execution, and market structure:
There is no definite answer about whether the new proposal will lead to more transparency. This particularly relates to the open issues of pre- and post-trading information and the question of how to consolidate market data and prices.
The influence on price-building mechanisms is unclear. Unanswered questions remain on whether there should be some kind of a reference market to avoid price distortions and how to detect price manipulations whenever they occur
How to ensure ‘best execution’ and what does it really mean.
Whether the market structure ensures access to the different systems and what will be the cost to investor.
He concluded that the current version of the Commission proposal is not yet sophisticated enough to deal with possible problems resulting from ATS and the internalisation of orders. Further work and examination has to be undertaken.
Mr Lefebvre, Executive Vice-President of Euronext, strongly opposed the new approach of the Commission. According to Euronext, authorising internalisation will lead to fragmented securities markets, reduce liquidity, undermine price formation mechanisms, and reduce investor protection.
The main minimum conditions for such activity should be:
pre-trade transparency,
order handling rules to ensure correct price-building mechanisms and investor protection,
harmonisation of European investor protection rules and open access to internalised systems.
As the ISD does not imply any progress on the cross border operations of regulated market operators, the harmonisation of requirements for operation of markets is minimal. Moreover, back office issues for cross-border operations are not dealt with.
So Euronext does not support the new orientation. Lefebvre concludes that the revised ISD threatens the competitive assets of most of the European equity markets.
On closing the discussions, Mr Wright referred to the two philosophies confronting each other: those of a market driven culture and those of an order driven culture. It is now up to the Commission to integrate the different views and different trading schemes to an overall system. Given the timetable of the Financial Service Action Plan, he opposed the idea of undertaking further investigations into the possible impact of internalisation on markets and price-building mechanisms.
Note:
Mrs Villiers has been designated as the Parliament’s rapporteur on the forthcoming Investment Services Directive. It is expected that ISD will be the first Directive which will be decided under fast-track procedure. With the proposal being published in November/December this year, European Parliament might provide its report by March 2003. So final adoption is thus expected in June 2003.
Commission press release
© Graham Bishop
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