Members of the European Parliament, politicians from EU member states and Brussels bureaucrats are locked in debate over the draft revised Investment Services Directive (ISD), one of the key parts of commissioner Frits Bolkestein’s plans for an integrated European capital market.
What worries banks most is a clause that will force them to quote publicly bid and offer prices at which they are obliged to trade, rather than keep some deals in-house. Banks claim that stock exchanges are trying to steal business, and stock exchanges say banks are trying to profit by misleading investors.
Supporters of the plan, including continental European stock exchanges such as Milan and Frankfurt, say the pre-trade transparency provisions contained in Article 25 of the ISD will protect investors and ensure they get a better deal from their brokers.
Fabrizio Plateroti, head of regulation and post-trading at Borsa Italiana says: “In a very fragmented market, pre-trade transparency allows a better price-discovery process and acts as a market integrity tool. And through that, we can provide a better best-execution process.” If all possible venues through which an investor might execute a trade are forced to quote bid-offer prices, prices will find their most competitive level.
Opponents of Article 25 on the other hand, including many in the City of London, say the plan will chill trading and undermine the European economy. They argue that imposing the same structure of trading venues across the EU is a recipe for competitive paralysis. At worst, it could encourage bankers to look elsewhere for more trading friendly regimes.
“If you remove a lot of liquidity from the market you remove the capacity to make profit,” says Michael McKee of the British Bankers’ Association. “It seems to me you could also have a serious economic impact on European growth. This could cut percentage points off European economic growth over the next decade.”
So how did this conflict arise? Back in 1993 the EU adopted a first Investment Services Directive after five years of political wrangling. A compromise deal allowed member states to opt into a concentration rule requiring certain orders to be executed through national exchanges.
The UK never exercised its right to enforce the concentration rule, but instead developed a sophisticated best execution practice obliging banks and brokers to get the best deal for their clients. UK bankers say it is this, rather than any mandatory disclosure rule, that wins investor confidence.
Ten years on, and the push towards closer integration in European capital markets is getting stronger. Politicians want to see more competition among stock exchanges and more movement of capital across borders. Thus concentration is to be abolished.
Exchanges fight against internalization The European Commission triggered controversy in November when it gave in to pressure from a number of exchanges by adding a pre-trade disclosure regime for internalized trades to the ISD. Bankers say this was simply a trade-off for ending the concentration rule.
City bankers accuse exchanges of trying to suck their profitable internalized trading onto public exchanges by removing the benefits of privacy. Exchanges counter this by saying the bankers want to keep end investors in the dark about best prices and benefit unfairly by doing so.
Securities firms say pre-trade transparency will deter brokers from doing deals because it will force them to trade at the prices they quote, regardless of how much stock a customer wants to buy. “In the view of the industry it would result in much wider spreads,” says Mark Harding, group general counsel at Barclays. “Firms won’t want to show their best prices. They will only quote a spread at which they are prepared to deal with any customer, however large or small.”
And Harding says the problem will be magnified if the proposal extends from the retail to the wholesale market. He argues that mandatory disclosure could deter firms from doing big block trades if they were forced to reveal their deals to the market. This would stop banks from executing customer trades as quickly, or with as much price certainty, and that could reduce rather than increase market liquidity, Harding says.
Atilla Ilkson, senior counsel at Merrill Lynch, warns that Article 25 could harm the European equities market in the same way that US regulations drove the Eurobond market to London 40 years ago.
The influential parliamentary committee on economic and monetary affairs votes this month on a report prepared by Theresa Villiers, a UK member of the European Parliament. She has backed calls for Article 25 to be removed, but the debate will be fierce. So far, committee members have proposed more than 400 amendments to the ISD. A plenary vote is expected in September before member states get their say in council discussions.
And the row is likely to continue. In late June the European Central Bank joined the debate, calling on the commission to extend the price transparency regime proposed for share trading in the new Investment Services Directive to debt security trading. Verena Ross of the UK Financial Services Authority says: “There’s certainly potential here for things to get worse rather than better.”
